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Here’s why the Ocado share price scares me and why I’m steering clear

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To say that the last six months have been eventful for Hatfield-based online grocery retailer Ocado (LSE: OCDO) is something of an understatement.

In only a short period of time, the company has gone from being one of the most hated stocks on the market to entering the FTSE 100. The reason? A series of partnerships with some of the world’s biggest retailers to use its software and “robotic infrastructure solutions” — the most recent being US giant Kroger and summarised here by my colleague Roland Head.

Had you invested in Ocado one year ago, you would have multiplied your capital by more than 250%.

But hindsight is wonderful. The question is whether the shares might still be worth buying. I don’t think they are.

Loss-making

Today’s interim numbers were something of a mixed bag. Total revenue rose 12.1% in the 26 weeks to 3 June, coming in at just under £800m. The vast proportion of this (£736.6m) came from its retail business — up 11.7% despite the severe weather experienced in March. This significantly outpaced the 2.3% sales growth achieved by the UK market in general.

Thanks to huge amounts of investment however, group EBITDA fell from £45.2m to £38.9m in H1. The company also recorded a pre-tax loss of £9m — a big contrast to the £7.7m profit achieved one year ago.

As far as its outlook is concerned, Ocado estimated revenue growth of between 10%-15% in the current financial year, barring any economic shocks. Retail earnings are expected to “improve significantly” in H2 due to lower engineering costs, but further investment in its platform means that earnings at its Solutions arm (which reported £63.3m in revenue) are forecast to decline further. 

Ocado’s share price was fairly volatile in early trading, suggesting that at least some market participants felt it was time to bank profit. I don’t blame them.

Crazy valuation

Sure, with its ambition to “change the way the world shops“, the possibility that its platform may become the go-to option for online grocery retailing is an enticing narrative for growth-focused investors.

Raising money to fund ongoing investment doesn’t seem to be a problem either. Thanks to recent deals and placings, Ocado had almost £450m in cash at the start of June compared to just £37.8m in 2017.

No, for me, Ocado’s biggest weakness is simply its valuation. With a market cap already close to £7bn, I strongly suspect it will struggle to reward investors in the way some expect. Increases in revenue might eventually translate into profits but, with most of the partnerships still to be fully operationalised, the execution risk remains substantial.

Trying to predict the direction of the share price over the very short term is fruitless. Moreover, it’s out of line with the Foolish philosophy of buying quality companies at reasonable prices and holding for years rather than weeks.

If you believe that Ocado can deliver on its many promises — which includes attracting more retailers to its platform “over the medium term” — then I can understand the desire to hold the stock.

For me however, the weight of expectation is likely to prove too much. Should the company underperform even slightly, you can expect momentum-hugging investors to sprint for the exits.

In what appears to be an increasingly skittish market, that’s not a risk I’m prepared to take.

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Paul Summers 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.