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Why I think the Ocado share price will continue to beat Tesco in 2020

Ocado Group (LSE: OCDO) lost approximately 10% of its sales capacity in the Andover fire in February 2019. Yet it still grew full-year sales by 10.3%. According to results released Tuesday, Ocado reckons that makes it the fastest-growing grocer in the UK.

By comparison, Tesco (LSE: TSCO) looks set to grow its revenues by less than 1% this year (judging by figures for the first nine months).

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That’s the good news for Ocado, but there’s bad news too. The costs of the Andover fire plunged it to a pre-tax loss of £215m, worse than last year’s £44.4m loss.

Ocado is still in its early growth phase, and raised new funding during the year to help drive that. A £600m convertible bond issue helped push the company’s cash total to £750m at 1 December, with £142m net cash.

Technology

While groceries sales are looking good, it’s really not where the focus of Ocado’s future growth lies. If it was only an online delivery outfit, I really wouldn’t be interested in the stock. And its valuation would surely be considerably lower.

No, at its core, Ocado is a technology provider, and it’s been signing up customers for its platform. New ones in 2019 include Aeon, one of Asia’s largest retailers, to build a network serving Japan with an expected sales capacity of ¥1trn (approximately £7bn) by 2035. Then there’s Coles, one of Australia’s largest retailers, set to open two Customer Fulfilment Centres in Sydney and Melbourne by 2023.

And finally, we have Ocado’s tie-up with Marks & Spencer. I’m not sure if that’s the best route for M&S, but I think it’s a good deal for Ocado.

Traditional

Getting back to Tesco, profits are expected to grow significantly ahead of sales, with analysts predicting an EPS rise of around 25%. In fact, from a low of 4p per share in 2016, we should be seeing around 17p this year. And forecasts have that growing to 19.5p by February 2022. Without doubt, that’s a seriously impressive turnaround.

But improving efficiency, lowering costs and focusing on profitability can only go so far. To win in the long run, you need to beat your competition for sales. And on that score, I’m not sure how well Tesco will do.

Tesco is the UK’s biggest supermarket by market share, but Lidl and Aldi are seriously encroaching on that. According to Kantar Worldpanel, the two together now account for 13.8% of the UK market and are growing. Tesco remains steady for now with 27.3%.

Fair value

Tesco’s shares are on P/E multiples of around 13 to 14, with dividend yields of 3%-4%. I see that as a fair valuation, but I also see it as fully valued. I reckon Tesco should be a safe and solid investment for the next couple of decades, but with a plodding rather than sparkling share price.

Meanwhile, I think the growth prospects for Ocado should see its share price pull ahead in 2020. But be aware that it’s still a risky investment.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. 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.