The City Is Turning Its Back On Ocado Group PLC

Ocado (LSE: OCDO) has been one of the market’s worst performers this year, falling more than 30% to date. The company is rapidly losing friends. Indeed, many investors and analysts alike are now starting to openly question the company’s business model and valuation. 

And it’s easy to see why. Ocado trades at a sky-high valuation of 161 times forward earnings, which makes the company one of the most expensive stocks listed in London. Nevertheless, investors have been willing to pay a premium to get their hands on Ocado’s shares, thanks to the company’s unique business model. 

However, some of the City most highly rated analysts have recently started to question the sustainability and uniqueness of Ocado’s business model.

Low barriers to entryOcado

A key part of Ocado’s business model is the use of technology to process customer orders. The company has been trying to license and sell its unique customer order fulfilment technology for some time. Unfortunately, according to analysts’ only one piece of technology, a robot arm, is uniquely patented to Ocado. 

What’s more, this robot arm is part of a machine which is manufactured by an outside provider, Swiss engineer Swisslog. After taking this into account, it would appear as if Ocado’s technology is not really very unique at all. 

Long time loser

City analysts have also started to call into question the quality of Ocado’s earnings. For example, according to one analyst after excluding accounting benefits from joint ventures, Ocado has not been profitable on a pre-tax basis at any point in its life.

Additionally, Ocado is unlikely to report a pre-tax profit, or positive cash flow for the next four years, after excluding accounting benefits. 

Room to grow

Still, these dismal forecasts are at odds with more optimistic brokers in the City. Indeed, some analysts are expecting international technology licensing deals before the end of the year.

Further, the company’s new warehouse model, promises to be quicker and much less costly to build, which should reduce costs and increase efficiency. Successful construction will also allow the grocer to accelerate its expansion plans around the country, boosting market share, revenue and ultimately profitability. 

That being said, there have been some questions about how Ocado will fund its expansion. Rumours have suggested a rights issue is on the cards, something the company has so far managed to avoid. 

But there’s no doubt that Ocado remains a risky bet. As the company trades at 161 times forward earnings there is little room for error. That’s trouble with growth companies like Ocado, investors are prepared to pay a premium for the shares.

But there are other opportunities out there. The key, when searching for growth stocks, is looking under the radar. You want to get on board while the company is still an unknown quantity.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.