Shares of online grocer Ocado Group (LSE: OCDO) rose by more than 40% in early trading this morning. The rise came after the company announced a deal with US supermarket group Kroger, which has sales of $122bn per year.
The partnership will see Ocado work exclusively with Kroger in the US, where it will build up to 20 new automated warehouses. To help fund the deal, the US group will take a 5% stake in Ocado, providing £183m of fresh cash.
This is the fourth international deal announced by the FTSE 250 firm in recent months, and by far the biggest. The market is clearly excited — Ocado shares have risen by 170% since May 2017. But should savvy shareholders be buying more, or taking profits?
Success at last?
Chief executive Timothy Steiner has been promising this kind of international growth for several years. He wants investors to see the business as a technology firm, using software, robotics and artificial intelligence to run retail websites and automated warehouses.
I can see this picture. My only concern is that each new deal requires Ocado to build new warehouses. This takes a lot of time and is expensive. The company spent £160m on capital expenditure last year, and expects this figure to rise to £210m in 2018. I expect it to be even higher in 2019 and 2020.
Show me the money
As with previous deals, Ocado has provided very little information about the financial impact of the Kroger partnership.
The only partnership deal currently in full operation is with Morrisons in the UK. This generated revenue of £117.7m last year, but had operating costs of £115.1m, giving an EBITDA profit of just £2.5m. That’s a margin of just 2.3%.
Overseas contracts may be more profitable. We don’t know. But I’m not convinced this business will ever deliver the high profit margins seen elsewhere in the tech sector.
Should you buy?
Today’s £5.1bn market-cap prices the stock at 2.9 times 2019 forecast sales and 2,800 times 2019 forecast profits. I think it will be many more years before the group’s profits start to justify the current share price, even if things go well.
I’d avoid this stock at current levels and would consider selling some shares to lock in a profit.
A tech stock I’d buy today
If I was looking at a tech stock to buy today, one company I’d consider is marketplace website Auto Trader Group (LSE: AUTO).
During the six months to 30 September, this business generated an operating profit of £109.6m on revenue of just £165m. That’s an operating profit margin of 66%. In comparison, Ocado achieved an operating margin of 1% last year.
One reason for this is that Auto Trader doesn’t have to invest in costly warehouses and delivery operations. Its investment is limited to web hosting, marketing and software development. The group also benefits from being the leading player in this sector. Anyone selling used cars pretty much has to advertise on Auto Trader.
This is an exceptionally profitable business, and it’s still growing. Earnings per share are expected to rise by 12% to 17.6p per share this year. This puts the shares on a forecast P/E of 21, falling to a P/E of 19 for 2019.
Although the dividend yield of 1.5% is low, I expect stronger dividend growth in future years. I’d rate this stock as a buy ahead of next month’s results.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Auto Trader. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.