Last week, rumours started to spread that high street retail stalwart Marks & Spencer is planning to roll out a new food delivery service, supported by Ocado (LSE: OCDO).
This could be the latest in a string of deals Ocado has signed with retailers around the world who are looking to improve their internet offering as consumers increasingly move online to do their shopping.
These deals have helped push the Ocado share price to new heights with the stock hitting an all-time high of 1,133p in July last year. Although it has since given up some of these gains, it’s still vastly outperforming the Footsie 100. Indeed, over the past 12 months, the stock has smashed the UK’s leading blue-chip index by just over 100%.
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However, if you want to join the party and buy into the Ocado growth story, there are several things I think you should be aware of first.
Future growth
The first point I think investors should be aware of before buying the Ocado share price is that this is very much a future growth story.
While the company has signed some potentially game-changing agreements over the past 24 months, it’s still miles away from profitability. The City is not expecting any kind of profit for the next two years, and I don’t expect the business to become self-sufficient anytime soon.
Takeover potential
Secondly, Ocado has often been touted as a possible takeover target, thanks to its unique robotic technology.
It has been speculated that Marks & Spencer could be interested in buying the retailer’s food delivery operations, although this isn’t realistic because the high street retail giant already has debt equal to 2.75 times earnings, (net debt of £1.6bn) and buying Ocado could cost as much as £6bn.
Other companies with deeper pockets might be interested. But after the recent share price rally, Ocado isn’t cheap, and the new price tag is almost certain to have discouraged bidders.
Show us the money
Finally, as I’ve noted above, Ocado isn’t expected to report a profit for the next few years, and this makes it hard to value the business.
Ever since it first hit the market, the group has struggled to generate enough cash to keep the lights on. Thanks to investor support, management has been able to raise enough to maintain operations, £800m over the past 10 years to be exact.
And even though it has signed some lucrative deals over the past 24 months, cash generated from these agreements is projected to be limited. The biggest deal is with US retailer Kroger and it will order 20 depots from Ocado over the next three years. This could generate as much as £250m in free cash flow per annum for the company, which is entitled to a certain percentage of Kroger’s online sales fulfilled in the depots. That’s not a particularly attractive rate of return on the current market valuation of £6bn.
The bottom line
So overall, after doubling in the space of the year, the Ocado share price might look attractive, but after considering the above, it seems to me as if there’s plenty of hope already built into the share price at this level.
For the share price to move higher, the company needs to go beyond what it achieved in 2018. That might not be possible.
