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Smart Investor: will Ocado ever deliver?
Upmarket online grocer Ocado (OCDO.L) has huge potential, but can it turn a profit? Smart Investor gives his take on the prospects for the shares.
FTSE 250-listed Ocado (OCDO.L) divides opinion. Supporters of the UK’s only dedicated online supermarket say the company has the scope to revolutionise the way that people buy their groceries, and that a few difficult years will soon be forgotten once Ocado delivers on its vast potential.
Others, however, see a delivery company that calls itself an online supermarket offering customers a fair deal and investors a raw deal, as the company has yet to deliver anything but groceries (and certainly not a net profit) to investors.
Ocado’s story began in 2000 when three former investment bankers began delivering Waitrose goods within a small area near St Albans, Hertfordshire. The operation expanded rapidly and soon Ocado’s delivery area had grown to more than 10 million households.
Waitrose remains the major supplier, with the two companies signing another 10-year agreement in 2010. Today, Ocado employs more than 5,000 people, makes 18,000 deliveries per day and, with a market capitalisation of £342 million, is the 345th-biggest UK listed company.
In terms of performance, the past five years have been disappointing. As mentioned, Ocado has yet to make a net profit. Its website lists various milestones such as ‘Ocado became earnings before interest, taxes, depreciation and amortisation (Ebitda) positive in 2007’ and ‘Ocado became pre-tax earnings positive for the final quarter of 2010’, but these are hardly major achievements.
Any company in the world is ‘profitable’ if you look far enough up the profit and loss sheet, before too many costs have been deducted from revenues.
So, no return on equity or net profit growth rate can be analysed. Of course, Ocado’s marketing department will point out that the company made a net profit of £181,000 for the first half of the current financial year. However, this works out at just £36.20 per employee over the course of 24 weeks. As for a yield, the word ‘dividend’ is mentioned 41 times in the 2011 annual report, but shareholders are still waiting for one.
Meanwhile, Ocado’s debt levels are fairly moderate at 28.4% using the debt-to-equity ratio. However, a lack of profitability means the company struggles to service this debt, with interest cover being just 1.1 and a hefty finance lease liability significantly adding to finance costs too.
Furthermore, the company appears to lack even the most basic of economic moats. Customers may argue that it provides a very good service and sells quality items at fair prices. However, an investor needs far more than this; barriers to entry, resilience in tough trading conditions, product differentiation, pricing power and brand loyalty are required by investors but not offered by Ocado.
Of course, a true cynic would argue that Ocado benefits from the ultimate barrier to entry. Why would anyone want to enter an industry in which the major player has never made a profit?
With shares currently trading at 65p, Ocado’s price-to-book ratio is 2.1 and its price-to-earnings (P/E) ratio is negative using 2011 earnings per share figures. The shares have been as high as 285p in February 2011, and have traded between a low of 58p and a high of 132p in 2012. Needless to say, shares do not offer good value at current levels.
Indeed, it seems Ocado still believes that potential, and not profits, is always the answer to criticism when, in reality, losses are the capitalist world’s way of telling a company that it has failed. Ocado may offer its customers a fantastic service but, unfortunately, it seems to only be able to do so on a not-for-profit basis.
Supporters of Ocado may argue that the company is 10 years too early, that the UK is not quite ready for an online only grocer that undoubtedly has major green and environmental credentials. However, it seems to me that Ocado is actually 10 years too late. The tech bubble, when companies making no profit but with great ‘potential’ were trading at ridiculous prices, burst over a decade ago.
Can Ocado turn its fortunes around? Maybe, but the chances of it doing so are too slim and the cost of taking the risk far too high for Ocado to be a realistic investment opportunity.
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by Michelle McGagh on Jun 19, 2013 at 12:07