Like so many growth stocks, the Ocado (LSE:OCDO) share price has been struggling to find traction as of late. It is now trading at levels last seen in early 2020 and is 60% off its all-time high of a year ago. Assessing whether or not this former lockdown darling can deliver long-term sustainable returns is the key factor for me in determining its investment case.
Online trends
The onset of the pandemic was really a watershed moment for the industry. Unlike other aspects of retail which had long ago been disrupted by digital technologies, online grocery shopping was lagging behind. The pandemic changed all that.
However, as normality returns, the latest research by Kantar last month suggest that consumers are once again returning to previous habits. Unsurprisingly, therefore, in its quarterly update this week, Ocado saw retail revenue decline 5.7% from a year ago.
Of course, I don’t base my investment decision purely on one quarter’s figures. Although the pandemic accelerated a move to online, I don’t believe this trend to be transitory. Today, driven by mobile technology, consumers expect a seamless experience in every aspect of their lives. To my mind, this interconnected, anytime, anywhere culture is only going to accelerate in the coming decade.
Trading environment
The near-term outlook for Ocado is undoubtedly challenging. As inflation continues to rise on the back of soaring energy costs, customers are going to becoming increasingly price-sensitive. Wage-price spirals are also hurting the business as it struggles to recruit enough delivery drivers. Couple that with intense competition in the grocery space, and margins are likely to remain under pressure for some time.
How long these challenges remain ultimately depends on how long higher inflation sticks around. Personally, I am of the view that it is here for some time to come.
A loss-making business
Since its launch in 2000, Ocado has never made a profit. Last year, it made a loss of £176m. This is concerning particularly given the pandemic-fuelled stimulus already discussed. Of course, virtually every disruptive business is loss-making in its early days. But Ocado isn’t a new venture.
The real engine of growth, though, is not its retail venture – which is 50% owned by M&S – but Ocado Solutions. Here, it provides Ocado Smart Platform (OSP) as a managed service and support proposition to several retail partners across the globe. Indeed, it is the only end-to-end solutions provider for online grocery fulfilment.
The business is spending heavily as it develops the next generation of robots. It recently rolled out the 500 series that enables more seamless maintenance. It is now working on the 600 series under the slogan ‘Ocado Re:Imagined’. This, it claims, will represent a step-change to the customer proposition of an OSP, enabling shorter lead times and greater productivity performance.
The delivery of transformational technology comes at a cost with hundreds of millions being spent. This is a far cry from a capital-light model that one traditionally comes to associate from an online-only business.
As costs pressures continue to mount from a variety of sources, I fail to see how Ocado will become a profit-making business anytime soon. Indeed, I still believe it to be overvalued relative to its fundamentals and ongoing challenges. I would not be surprised if the share price falls a lot further from here. Therefore, I won’t be investing.
The post With the Ocado share price down 60% in a year, is it a bargain or a value trap? appeared first on The Motley Fool UK.
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Andrew Mackie has no position in any of the shares mentioned. The Motley Fool UK has recommended Ocado Group. 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.
