Shares of online grocer Ocado Group (LSE: OCDO) rose by as much as 6% on Monday morning, after the company said it had found a new customer for its online shopping software. Does this mean that after an uncertain couple of years, Ocado’s growth story is back on the road?
What’s good and what’s not
Chief executive Tim Steiner would like investors to rate Ocado as a high-tech growth stock, not an online retailer. Mr Steiner’s vision is of a company that licenses its software and automated warehouse systems to supermarkets and retailers around the world.
Today’s news is a step in the right direction. Ocado says that a “regional European retailer” has signed up to use the Ocado Smart Platform (OSP). The deal will initially be for the online part of OSP only, but includes an option to add the automated warehouse elements of OSP in the future.
Ocado will receive an up-front fee plus ongoing payments based on the volume of products sold online. The arrangement is expected to be “earnings and cash-neutral” until the end of the 2018 financial year, after which it should add to earnings.
The problem for investors is that this is all we know. Ocado says that the retailer wants to remain anonymous until it launches online, in order to preserve its competitive advantage. Fair enough, but why hasn’t Ocado provided any information about the expected value and duration of the contract?
In my view, its reluctance to reveal any information suggests that the deal is smaller than the group’s arrangement with Wm Morrison Supermarkets, which netted the group £19.5m in fees last year.
Ocado is expected to report a profit of just £16.1m in 2018. That’s not much for a company with a market cap of £2bn. The group’s stock trades on a 2018 forecast P/E of 119, with no dividend. I’d sell at current levels.
A quality alternative
Photo-Me International (LSE: PHTM) operates automated photo booths, laundry machines and other such self-service facilities in the UK, France, Germany and Ireland. This may seem like a dated business that’s at risk of become extinct, but the facts suggest otherwise.
Photo-Me issued a year-end trading statement last week, confirming a year of “excellent progress”. Pre-tax profit for the year is expected to be up by 20% compared to last year, “supporting the group’s stated commitment” to increase the dividend by 20%.
One reason for the group’s success appears to be that the requirements for passport and driving licence photos are increasingly complex and precise. Taking a compliant photo yourself with a smartphone is difficult. Photo-Me’s machines guarantee a usable photo and can upload pictures automatically to the relevant government agency.
Similarly, while laundrettes are increasingly rare in the UK, many European supermarkets provide outdoor self-service laundry machines. This is another growth area for Photo-Me.
Trading on a forecast P/E of about 18, Photo-Me stock isn’t cheap. However, the prospective dividend yield of 4.1% is attractive and should be backed by the group’s net cash, which totalled £65m at the end of October. Photo-Me is highly profitable and has reported an operating margin of almost 22% in both the last two years. I believe these shares could be an excellent long-term buy.