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I am more than glad I did not invest in Ocado (LSE: OCDO) five years ago. Since then, the FTSE 250 stock has shed a phenomenal 93% of its value. Last week, it hit not only a low for the past 12 months but for the past 12 years!
Still, with its large customer base, well-known digital retail operation in the UK and expertise in helping other retailers across the globe manage their online operations, could this be a share poised for recovery?
Two businesses in one
Not everyone understands that Ocado is basically two businesses.
One is its UK online operation, run as a joint venture with Marks and Spencer. The other is the arm that helps other retailers worldwide manage their online operations. That includes managing warehouses as well as the software side of things.
I think there is a logic to those two businesses going together. The UK operation is a proof of concept that has allowed Ocado to develop and hone the technology it sells to other retailers.
An unproven business model
However, from a valuation perspective, a digital retailer in the brutally competitive British grocery market may be less compelling for some investors than a scaleable tech solutions company.
Is Ocado even a scalable tech solutions company? Its tech may be scalable, but building and maintaining physical properties like warehouses is the stuff of traditional real estate more than tech.
Either way, while the retail operation has sometimes been profitable in the past, the tech part of the business has been a relentless money pit. As far as I am concerned, the FTSE 250 company is yet to prove that its business model can work when it comes to being sustainably profitable.
Positive signs, but lots still to prove
In the first half of the year, Ocado recorded year-on-year revenue gains of 13%.
Having focused on turning cash flow positive next year, the first half of this year saw the company’s cash outflow reduce sharply compared to the same period last year.
These are positive signs – so why has the FTSE 250 share been sinking in value? A key reason was an announcement by Ocado’s US client Kroger in September, when it said that it was conducting a detailed review of its automated order fulfilment network.
Clearly that has alarmed the City. Investors seem fearful that Kroger may be unhappy, in what would be a big blow for Ocado both in terms of revenue and credibility.
Time will tell
However, for now we do not know the details of Kroger’s review. Whether it turns out bad, neutral or even positive for Ocado remains to be seen.
Postive? Well, it is a possibility. Kroger may conclude that Ocado’s market-leading offer is so good it wants more of it. Then again, it may not.
Over the long term, especially if Kroger ends up sticking with Ocado, the current share price may come to seem like a bargain. However, I am not ready to invest, given the lack of profitability. I remain to be convinced that Ocado’s current business model is a good one over the long term.
