It’s been a banner year for shareholders of Ocado (LSE: OCDO) as they’ve seen the online grocery delivery platform’s share price jump over 160% since the beginning of January and join the FTSE 100 index.
This is entirely due to Ocado’s management finally signing much-ballyhooed international distribution agreements to provide the technical know-how and physical infrastructure to foreign grocers to support their online delivery platforms. These agreements, five of which have been signed in the past few months, have led investors to no longer value Ocado as the lossmaking online grocery delivery service it is today, but rather as the highly scalable, high-value-added technology platform it has promised to be.
Looking ahead, there’s clearly scope for the firm, which has positioned itself as the market leader in this segment, to sign further agreements as grocers the world over scramble to adapt to shifting consumer habits and the spectre of increased competition from e-commerce retailers.
However, in my eyes, there is still plenty of work to be done f0r it to grow into its new £6.9bn market cap that looks very, very rich against the mere £86m in EBITDA and £1m in statutory pre-tax profits posted last year. This is particularly true as the business is bleeding huge amount of cash as it invests heavily in its technology platforms and the actual warehouses its customers order. In H1 2018, these capital investments climbed to £101.2m while group EBITDA dropped slightly to £38.9m.
These investments follow the classic tech playbook of investing heavily initially to gain market share and only worrying about profits later, which is a valid strategy and can work as long as investors or creditors are willing to provide recurring capital injections. This is the case with Ocado, which raised £143m from a rights issue in February and secured a £183m investment from US grocer Kroger in May.
Following these capital injections, it has plenty of cash on its balance sheet and I reckon it should be able to sustain current investment levels for at least a year or two without needing to once again tap shareholders for funds. This may not be the case if agreements with new foreign partners require high initial outlays from Ocado though, which we do not know as few hard details about these agreements have been revealed – another reason to exercise caution.
That said, in the long term there is clearly plenty to be said for the plan to pivot from a low-margin delivery service towards becoming a high-margin provider of advanced, heavily-automated fulfilment centre technology for grocers. While management annoyed many investors, myself included, with their failure to sign these long-promised foreign agreements years ago, it’s good to see them now signing new partnerships as fast as the ink is dry on the last one.
Ocado has huge potential in the long term if management can continue to find new partners to sign profitable deals, but at its current market cap, the market has clearly already priced-in significant amounts of highly profitable growth. This is enough to keep me on the sidelines while we wait for further details on these contracts and see whether the company’s investment levels will rise significantly going forward.
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Ian Pierce 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.