The supermarket strategy of offering ‘buy one, get one free’ deals appeals to many people. Right now, I could do the same with online retailer Ocado‘s (LSE: OCDO) shares. Specifically, after a 50% fall, I can now buy two Ocado shares for the price I would have paid for a single one 12 months ago.
Could that be a good recovery play for my portfolio?
I do not think so. In fact, I would not touch Ocado shares with a bargepole. Here is why I am loath to invest in the company.
The investment case rests on the idea that Ocado is developing a compelling tech-driven platform that enables online grocery retail for large customers across different global markets. I think that is what drives the market capitalisation of almost £6bn.
After all, although Ocado does have a retail operation of its own, its sales in the first half came in at £1.1bn. Not only did that represent an 8% decline from the prior year period, it was just 4% of the equivalent number (excluding VAT and fuel) at leading grocer Tesco during the first half of its financial year. Tesco actually generated more from retail operations in free cash flow alone than Ocado did in revenue.
Despite that, the Ocado market capitalisation is 33% that of Tesco. I think this reflects the fact that most investors are not valuing Ocado as a retailer, but as a solutions provider for online retail.
But that part of the business is unproven, in my view. Overall, it is markedly smaller in revenue terms than Ocado’s retail business – and heavily lossmaking. Last year, across its total business, Ocado racked up another £186m of losses.
The solutions business could ultimately be a strong performer. Online retail demand is growing. Retailers are looking for a proven management and logistics solution that they can use rather than reinventing the wheel themselves.
Ocado’s client list includes international retailers such as Kroger and Coles, so its approach seems to be gaining traction. In November, the company announced a deal with large retailer Lotte in the highly competitive Korean market. That is further proof to me that its platform has great potential.
Costly business model
My concern, however, is with the business model. Ocado is not just selling software. It is building warehouses to service clients. This requires high capital expenditure, something I think could be a drag on profits for years or even decades.
A trading statement this week showed retail revenues declining last year, but my bigger concern is with the solutions business model. It involves sizeable long-term financial outlays on a client by client basis. So unlike tech models such as that of Shopify, platform scalability here comes with significant marginal costs.
Should I buy Ocado shares?
I therefore have no plan to add the company to my portfolio. Even if the retail business starts to fire on all cylinders, I think rivals like Tesco have more attractively priced shares.
Meanwhile, the solutions part of Ocado’s business looks to me like a money pit for the foreseeable future. It could make large profits in future. But, until then, I do not see it – or Ocado shares – as attractive.
The post Ocado shares have halved. Why am I still not buying? appeared first on The Motley Fool UK.
C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Ocado Group Plc, Shopify, and Tesco Plc. 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.
Motley Fool UK 2023