Ocado (LSE:OCDO) is about to fall out the bottom of the FTSE 100 due to its declining share price. However, could investors’ lack of confidence in the company mean that the shares are undervalued? While it’s not yet reliably profitable, the business model is strong, in my opinion.
The best for less
The company has an “Ocado Price Promise”, which matches over 10,000 products to Tesco’s prices. They claim customer’s get “Ocado quality at Tesco Prices”.
I can attest to the standard myself, as I’ve used Ocado delivery for a few months now. Having personally used Waitrose and Ocado for internet shopping, I’d say the service at Ocado is better. Additionally, the range of options is arguably larger, including a selection of Marks & Spencer food, with which Ocado operates a joint venture.
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The financials tell a different story
In a nutshell, Ocado’s revenue has been growing steadily and with a lot of strength, but its earnings have yet to bear fruit reliably.
Over the past 10 years, it has delivered 10.8% revenue growth annually. On the other hand, its earnings per share have decreased from £0.02 at the end of 2015 to -£0.59 at the end of 2022.
Part of the reason the earnings are in decline is that the company has to invest continuously in its technology and infrastructure. This includes automated warehouses and expansion costs related to operating internationally.
In some respects, the losses at the moment could translate to long-term gains. However, Ocado needs to be careful it doesn’t get caught in a cycle of spending to stay relevant and never translate this into proper profits. It needs competitive efficiency, not just to keep up with trends, which is very hard to cultivate.
Is this a long-term opportunity?
One of the elements of investing that Warren Buffett taught me is to be greedy when others are fearful. Sometimes, buying a company when investors have lost faith can lead to big long-term returns.
In the case of Ocado, if it manages to translate its growing revenues effectively into good earnings over the long term, I think I could be in for a big win if I buy in at this time.
However, I have to caveat this by saying it’s high-risk. While the share price may be down nearly 90% from its all-time high, some companies never make a profit sustainably. If Ocado fails to do this over the long term, eventually, it will go bust. Nonetheless, its current price-to-sales ratio of roughly 1.1 is appealing to me.
Smaller is sometimes better
When I believe I’m on to a good thing, I go all in. However, sometimes it’s not clear whether a company is going to be sustainably great. I believe I can tell early on with some companies and people, but in the case of Ocado, I’d want more evidence first.
Therefore, if I do invest, it will be part of a diversified strategy. I might start with a small allocation of roughly 2% of my total portfolio and build up over time if it starts to look like it will become profitable.
Right now, I’m on the sidelines on this one. However, it’s going on my watchlist for sure.
