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Are Ocado shares a good long-term investment? 

by | Last updated 26 Nov, 2022 | Consumer Staples

Key points

  • Ocado shares are down over 70% year to date.
  • Ocado opened 16 Customer Fulfilment Centres (CFC) Internationally.
  • The company launched its first fully automated microsite for Ocado Retail in Canning Town.

Ocado Group Plc (LSE:OCDO) shares have had quite a rough 12 months falling by more than 73%! Between 2018 and 2021, the online grocery robotics hybrid business saw tremendous success, with its stock price surging by more than 400% in just three years. Yet most of these gains have been wiped out in the last 18 months.

The company’s market capitalisation is still significantly higher than its initial listing on the London Stock Exchange in July 2010. But the giant reversal in valuation has understandably been concerning for shareholders.

So, is this a sign to steer clear? Or has an enormous buying opportunity in the stock market emerged for my portfolio? And should I buy Ocado shares after its latest financial results? Let’s take a closer look at this business.

What does Ocado do?

Ocado Group is an online grocery retailer founded in April 2000 with its headquarters in Hatfield, United Kingdom. Its heavy investments in robotics automation make it stand out from countless other companies in this space.

Today, all of its warehouses are using robots to accept, process, and package customers’ orders for delivery. This extreme level of automation has led to exceptional order volume capacity at its facilities that work around the clock. And the firm has subsequently begun selling its solution as a service to other grocery retailers through its Ocado Smart Platform (OSP).

Ocado operates through several segments: Ocado Retail, UK Solutions and Logistics, International Solutions and Technological Solutions. However, it’s important to note that the bulk of revenue and cash flow still originates from its retail arm, which is formed as a joint venture with Marks & Spencer Group.

Why did Ocado’s share price drop?

A lot of the momentum behind Ocado stock pre-2021 seemed to come from the tailwinds of the pandemic. With lockdowns keeping people at home, online grocery shopping gained a lot of popularity that saw the group’s cash flow surge.

At the same time, a lot of excitement started to emerge surrounding OSP, with new industry-leading retailers like Kroger, Morrisons, Coles, and Auchan adopting the warehouse automation technology.

But once lockdowns lifted and the tailwinds dissipated, excitement began to die down. As consumers returned to brick & mortar stores, revenues have been struggling against tough comparables.

Looking at its latest interim results, revenue has actually dropped by 4% to £1.26bn. This was largely driven by the 8.3% fall in sales of its Retail segment. With the cost-of-living crisis putting pressure on consumer spending, basket sizes have shrunk.

Meanwhile, the development and expansion of OSP are proving exceedingly expensive. So much so that net debt has gone through the roof from £188.5m to £758.8m. There is solid progress being made in bringing new customer fulfilment centres on-line around the world. But the cost of doing so seems to be far more than investors anticipated.

Consequently, the pre-tax loss for the first six months of 2022 came in at a record £221m! With that in mind, it’s not surprising to see Ocado shares plummet.

Will Ocado ever be profitable again?

After all the recent chaos, the company’s market capitalisation now stands at around £4bn. And Ocado shares continue to trade close to the bottom of its 52-week range that lies between 380.30p and 1,964.50p.

Is that a fair price to pay for a company that’s seemingly bleeding cash when interest rates are rising? Many investors are saying no, given the recent trajectory of the Ocado share price.

However, it’s not all dire news. While OSP continues to be a drain on capital, there are early signs that management’s investments are starting to pay off. The group now has 16 customer fulfilment centres on active duty. And subsequently, fee revenue from OSP operations is on track to double this year. In fact, revenue from its International Solutions division exploded by 119.9% so far in 2022.

OSP still remains a small contributor to the overall revenue stream. But it’s growing rapidly. And given time, it might eventually become the dominant part of this business, eventually leading to significant earnings. Therefore, I do see a path to profitability for this business with stronger future performance. But how long this process will take remains unclear.

Should I buy Ocado Group Plc shares?

Ocado looks like an exciting business even today. With retailers constantly seeking new ways to optimise operations, I only see demand for warehouse automation increasing over the next decade. However, while the product looks solid, the business needs some work.

For now, I’m keeping Ocado shares on my watchlist. It does have ample liquidity of £2bn to see it through the current economic environment. However, I’m waiting for a better idea of when this business can begin generating earnings again.

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Prosper Ambaka does not own shares in any of the companies mentioned in this article. The Money Cog has published a Premium report on Ocado Group Plc. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.

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