The UK stock market does not have anything like as many tech companies listed as its US equivalent. One company with a tech story and fairly high profile is Ocado (LSE: OCDO). Although its global footprint has grown, over the past five years Ocado shares have lost almost a third of their value.
Given the company’s potentially exciting long-term growth prospects, does it make sense for me to tuck some Ocado shares away in my portfolio at their current price?
Attractive business potential
In the long term, I expect online shopping to grow in size.
That could be good news for Ocado. It has spent several decades developing a model for fulfilling online sales. While many customers may associate Ocado with its own online shopping offer, the longer-term prize for the company is rolling out its backend capabilities to other retailers worldwide.
The business has already had considerable success doing that and has signed clients including Morrisons and US retailer Kroger.
Challenging model
The problem I see so far with the model however, is that it requires a lot of investment.
Ocado is not simply selling a software package that is easily scalable. Rather, it has been building dozens of sites to fulfil orders for specific customers. These include huge distribution centres and smaller ones focused on rapid urban deliveries. The idea is that building such infrastructure will enable the company to profit over the long term, while giving it a strong competitive advantage.
I think that could turn out to be correct. Indeed, that part of the long-term investment case for Ocado shares appeals to me. The problem I see is the cost-heavy business model. Additionally, Ocado is targeting an industry that typically has thin profit margins and so spends frugally.
In the first half of the year, the company lost £290m before tax. That was 37% higher than the same period last year.
Cash flows were even worse. Operating cash outflows were £16m. But adding in £289m of capital expenditure, cash outflow in the first half was £320m.
Ocado remains typically upbeat, saying that “further operating efficiencies and cost reductions will support growth in profitability” in the second half.
But the company has long been a cash pit, losing £481m last year. As it scales up, there is a risk that losses will remain large due to high capital expenditure. Indeed, that was exactly the pattern seen in the first half.
Share valuation
Over the past five years, Ocado shares have lost a fifth of their value.
The company still has a market capitalisation of £7.1bn. For a heavily lossmaking company with a business model I think remains to be proven when it comes to profitability, I see that as costly.
Ocado shares could yet be a rewarding investment if the company’s model matures and contract payments start piling up, while upfront capital expenditures decline.
My concern is whether that will ever actually happen at the right scale to justify today’s valuation, let alone a higher one. I have no plans to buy the shares.
The post Could Ocado shares be a winning long-term investment? appeared first on The Motley Fool UK.
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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Ocado Group 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.
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