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Ocado is set to storm into the FTSE 100. Time to buy?

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Ocado (LSE: OCDO) is poised for promotion to the FTSE 100 after its shares have soared around 60% over the last three months. The FTSE index committee will announce its latest quarterly review on Wednesday, based on the market capitalisation of companies at Tuesday’s closing prices. So, barring a major collapse in its share price between now and then, Ocado will join the blue-chip elite.

Elsewhere, ace fund manager Neil Woodford is set to receive another blow to his recently tarnished reputation, as his Woodford Patient Capital Trust (LSE: WPCT) is set to be kicked out of the mid-tier FTSE 250 into the FTSE SmallCap index.

Transformational deal

Ocado’s spectacular rise has come on the back of a fifth — and transformational — licensing deal, announced earlier this month. I believe this deal, with the US’s biggest traditional grocer Kroger, seals Ocado’s transition from a small, upstart UK grocery player to a global technology supplier for online grocery retailing.

The company had been promising this for years and its shares were always overvalued based solely on its UK business. The question for investors now is whether the recent rise in the shares has fully valued Ocado’s transformation into a global business or whether the market is underestimating the company’s prospects.

Build it and they will come

Ocado has a market cap of approaching £6bn, as I’m writing, which compares with, for example, Marks & Spencer at £5bn. Their respective revenues last year were £1.5bn and £10.7bn. However, a number of analysts model future revenues and cash flows that suggest there’s significant upside for Ocado’s shares. And this is without further international deals for its Smart Platform system, which now appears to have achieved go-to status.

The large number of projects Ocado has on its plate presents a degree of execution risk, but management’s record of operational excellence gives me confidence it can deliver. With the company now having demonstrated not only that it can ‘build it’, but also that ‘they will come’, I’m inclined to rate the stock a ‘buy’.

Poor risk/reward

In contrast, I moved Neil Woodford’s underperforming Patient Capital Trust onto my ‘sell’ list at the start of this year. This was on the basis that the trust has morphed into a far higher-risk proposition than when it was launched. I suggested that a discount of less than 10% to net asset value (NAV) was far too narrow for the increased risk.

Patient Capital is invested in ‘disruptive’ businesses (but not Ocado) and has seen a number of significant failures. The shares have fallen around 10% since January — precipitating the trust’s imminent demotion from the FTSE 250 — but the NAV has also fallen. As such, the discount is still less than 10% and the stock remains on my ‘sell’ list.

Changes to the FTSE indexes, including the likely ejection of security firm G4S from the FTSE 100 to make way for Ocado, will take effect from the start of trading on Monday 18 July.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.