The FTSE 250 has generated a near-32% return over the last five years, including dividends. While that’s not as impressive as the near-94% gain from the FTSE 100, it’s nonetheless significantly ahead of the 90% loss that Ocado (LSE:OCDO) shareholders have had to endure.
The online grocery retailer and warehouse automation specialist has encountered a long list of problems over the years, from rising costs to top-tier customers rethinking their relationships.
The latter has been particularly painful. However, with Kroger breaking its contract, Ocado’s getting a handy short-term cash injection. And with its exclusivity requirements now out the window, the group can pursue other relationships to get operations back on track.
So could investors be looking at the beginning of a multi-year recovery story?
The bull case
The setbacks with retailers such as Kroger and, more recently, Sobeys have proven that Ocado’s original ‘one-size-fits-all’ warehouse automation business model has failed commercially. The high initial capital costs simply make it too financially challenging for customers, even in the long run.
In response, Ocado’s been shifting towards a more modular deployment approach, allowing retailers to use Ocado’s robotics and automation solution at a much smaller scale and with a much smaller initial capital commitment. And there are some signs this new approach could be working.
In fact, Ocado could be on the verge of turning cash flow positive this year. And providing no more surprise spanners are thrown in the works, by 2027, that could turn into positive free cash flow – a critical step towards financial independence.
If Ocado can demonstrate a path to profitability with its robotics technology, and its online grocery joint venture with Marks & Spencer continues to perform robustly, then this FTSE 250 stock could indeed be set for a rebound.
The risk remains high
Kroger’s decision to shut down three of its eight automated Ocado-powered customer fulfilment centres is a major red flag. If one of the largest retailers in the world was unable to make the technology work, convincing other smaller retailers to try is going to be a tough sell for Ocado’s marketing team.
Another significant challenge is the firm’s problematic debt. With £1.8bn of expensive debt & equivalents on its balance sheet, the firm’s now bleeding more than £100m a year to interest payments alone.
Luckily, management’s receiving $350m from Kroger as a penalty for breaking its contract, which has put aside any immediate liquidity crisis. But that’s ultimately only a short-term fix. If Ocado isn’t able to reach its goal of turning free cash flow positive next year, the debt problem could once again re-emerge down the line.
The bottom line
Looking ahead, there’s a plausible future where Ocado’s change in strategy puts the business back on track within a few short years. However, this is going to be an uphill battle dependent on strong execution. And with no new partner announcements made since the group’s exclusivity ended, the risk-to-reward ratio doesn’t look particularly enticing right now.
The company is reporting earnings later this week, so it won’t be long before investors get a detailed update on how things are progressing. For now, I’m keeping Ocado on my watchlist and looking for other opportunities in the FTSE 250.
