Ocado’s share price has fallen by 60% so far this year, but this sudden surge makes me wonder if the stock has now reached a turning point. Is it time to buy Ocado?

What’s happened?

Ocado’s business model is based on selling its automated warehouse technology to other retailers around the world. The company has just announced its first new deal for a while, with South Korean conglomerate Lotte Group.

Lotte’s business includes supermarkets and department stores with annual sales of nearly £10bn.

The Korean group’s deal with Ocado will see the pair develop a network of customer fulfilment centres (CFCs) in South Korea. These will be powered by the Ocado Smart Platform automation system.

Lotte and Ocado plan to have six CFCs in place by 2028, with the first live in 2025.

Show me the money

So far, Ocado’s international expansion plans have not generated any profit. The company reported a loss of £228m last year and is expected to remain loss-making through to at least 2024.

Ocado’s normal business model is that it funds much of the development of the CFCs. It then expects to collect regular service fees from its customers, once the CFCs are open.

Management says that this model will eventually lead to attractive profits. But we have to take this on trust. So far, the cash just keeps flowing out.

Ocado’s capital expenditure is expected to reach £800m this year, including £400m on building CFCs for customers outside the UK. The company has raised money from shareholders and borrowed from its banks so that it can continue spending.

Management doesn’t expect the business to start generating cash for several more years. But the company now has 16 CFCs live for its customers around the world. More are opening all the time.

My hope is that we’ll start to see revenue flowing from these operations. This might make it easier for investors like me to model how much Ocado shares could be worth.

Bull vs bear

The bull argument for Ocado is that it’s a bit like Amazon was in the early days. Amazon lost money for many years, but eventually became very profitable.

The bearish argument is that by the time Ocado finally starts to generate some cash, most of it will be used up by debt repayments and continued capital expenditure costs.

Ocado has previously claimed that its revenue could rise to more than £6bn in the future, generated underlying profits of perhaps £750m. If that could be achieved, then I suppose the shares could be cheap at current levels.

However, I can see no clear timetable for Ocado to become profitable. For me, it doesn’t make sense to invest in such an uncertain situation.

In my view, there are plenty of good, profitable businesses on sale at attractive prices in today’s stock market. I plan to continue buying such stocks. I’ll be avoiding Ocado shares.

Here are five reasons why I’m not investing in “the world’s largest dedicated online grocery retailer“.

1. No profit

Call me old-fashioned, but I like a company that makes a profit. In its 22 years of trading, Ocado has only made a full-year profit three times.

The company’s sales may have grown more than 70% over the past four years, but its loss before tax has deteriorated by £168m. And analysts don’t expect Ocado to be profitable any time soon.

2. No dividend

The company has never paid a dividend.

This is partly because it hasn’t been consistently profitable, but also due to a policy of reinvesting surplus funds into growing the business.

Retaining cash for investment is laudable but, to help me counter inflation, I like to own stocks that pay a decent dividend.

3. No cash

On 29 May, Ocado reported a net debt position of £759m. This had worsened by £947m compared to a year earlier.

In June, the company raised a further £875m — £575m through a rights issue and £300m via a revolving credit facility.

The board says it has no need to raise further funds, but if the losses continue for longer than expected, this will change.

Ocado is also a very capital-intensive business. It spent £559m on property, plant and equipment in 2021.

4. No growth

In its September trading update, the board disclosed that it expects growth in customer numbers and orders during the last quarter. But full-year revenue in 2022 will be lower than in 2021.

This is because customers are putting fewer items into their online shopping baskets.

During the third quarter, the average basket, at £116, was worth 6% less when compared to the same period in 2021. More worryingly, the number of items in the average basket was down 10%.

5. No logic to its valuation

Even with the significant decline in its share price, Ocado still has a market cap of £4.1bn. To put this in perspective, J Sainsbury made a profit before tax of £854m in 2022, but it’s valued at £4.3bn.

Marks and Spencer, which has a joint venture with Ocado, is profitable and has a stock market valuation of £2bn.

One of the lessons I learned from the dotcom crash is that just because a business generates all of its income online, it doesn’t necessarily make it a sensible investment.

No thanks

For these reasons, I won’t be investing in Ocado. Of course, I might regret this.

The board claims to have a “clear path” to generating revenue in excess of £6.3bn and EBITDA (earnings before interest, tax, depreciation, and amortisation) of £750m+ within four to six years.

At the moment, I remain to be convinced.

Despite this, I have found a company that has experienced considerable falls in share price over the last three quarters, and now presents a good opportunity for investment, in my opinion.

The company I am referring to is Ocado Group (LSE: OCDO), one of the largest online-only grocers in the world. The business operates almost entirely in the United Kingdom and has two main business areas: Retail and Logistics Solutions.

It is fair to say that the group hasn’t had the best start to the year, as its share price is down 71.8% since the beginning of 2022. Furthermore, the share price is down almost 84% since its peak in 2022. This is not a hugely encouraging sign, although it may still present an opportunity to invest at levels that are considered undervalued.

Underlying fundamentals

When looking at the underlying fundamentals, it is clear that Ocado has struggled with consistent profitability since its inception. This is normally the case when rapid growth is the priority. The fact that turnover has been growing consistently year on year confirms this is likely the focus.

In addition, despite Ocado’s borrowing accelerating from pre-pandemic levels, this has been accompanied by rising levels of cash and equivalents, which has kept net borrowing at a more manageable level. Net asset value is now around 40% of market capitalisation, which is quite encouraging for a growth company.

Growth opportunity

Another factor to consider, which falls outside standard fundamental analysis, is the progress being made by logistic solutions. It is this area that focuses on Ocado’s unique approach to order fulfilment, utilising high-tech factories and robot packing to completely revolutionise the grocery processing experience.

I believe it is the potential within this area of the business that the market tends to overlook. Continued developments within its software and hardware offering could help drive growth forward. This could help Ocado exceed the levels of its competitors within the supermarket and grocery sector.

Despite this, it’s important not to ignore the reasons why the share has fallen out of favour with the market. The company has seen large falls in profit levels and margins, and if top-level growth starts to fall, this could be a problem.

Nonetheless, I believe this fall has presented a good opportunity. This could allow me to invest in a high-quality growth company at an attractive valuation. Therefore, I would add Ocado to my portfolio once I achieve the necessary liquidity.

What are they?

Ocado describes itself as “the biggest grocery retailer of its kind in the world”, and hopes to take advantage of the long-term trend towards online shopping. Its Ocado Retail business is a joint venture with Marks and Spencer. Ocado says it has over 800,000 active customers.

BT claims to be “supporting customers to live, work and play together better”. Its consumer division boasts of 30m mobile and fixed broadband customers in the UK. BT also has another 1.2m business users.

What about their financial performance?

Ocado announced a loss before tax of £211m in its half-year results published in July, compared to BT’s profit of £482m in the three months to June.

Ocado has never paid a dividend.

Since it floated in 1984, with the exception of one year due to the pandemic, BT has always declared a dividend. BT’s yield is currently nearly 6% — well above the FTSE 100 forward-looking average of 4.1%.

Ocado reported revenue of £1.3bn in the 26 weeks to 29 May 2022, down 4% compared to a year ago. The company moved from a net cash position of £189m at May 2021, to having a net debt of £759m 12 months later — a swing of £948m.

BT’s sales rose by 1% to £5.1bn in the three months to June 2022, and its net debt increased by £325m compared to a year earlier.

Are they dirt-cheap?

So, are either of these shares dirt-cheap?

Ocado and BT have come onto my radar because of the recent dramatic fall in their share prices. But what is their underlying value?

Warren Buffett once said: “Price is what you pay. Value is what you get.”

A company can be valued based on either its assets or its future expected cash flows.

Ocado has only made a profit three times in 22 years, making it difficult to assess its earnings potential. Ocado’s current market cap is roughly three times that of its net assets of £1.6bn. To my surprise, Ocado has a stock market valuation equal to that of J Sainsbury.

BT has a track record of profitability. It’s current price-to-earnings ratio is seven, and is much lower than its FTSE 100 peers. BT had net assets of £15.3bn at the end of March, approximately 18% above its market cap.

Who wins?

So, if I had to choose between these two shares, BT would win hands down.

I am not alone.  

French billionaire Patrick Drahi appears to see potential in the telecoms giant, having quietly increased his stake to over 18% in recent months. Furthermore, the UK government has waived its previous objection — on grounds of national security — to Drahi’s interest.

But, I am not going to invest in either Ocado or BT at the moment.

It doesn’t seem right to me that Ocado is valued more like a tech stock than a retailer.

As for BT, I think its current market cap reflects concerns over its growth potential. BT has significant market penetration, and the current squeeze on disposable incomes will affect its ability to increase revenues further.

Supermarket shock

Ocado (LSE: OCDO) shares continued their fall during the week. They’re now down almost 70% over the past 12 months. Shareholders are still well in profit since flotation, though.

The latest dip is fallout from a trading update on 13 September, in which Ocado warned us to expect “a small sales decline in FY22 and close to break-even EBITDA“.

Despite that, the company’s all-in-one online selling package, known as the Ocado Smart Platform (OSP), is doing well. It provides a robotic warehouse automation package. And by the end of the first half this year, 11 partners in nine countries were signed up.

International revenue from the OSP business more than doubled in the half too.

The problem for me is that the bulk of Ocado’s revenue still comes from retail. The OSP business might have years of strong growth ahead of it. But I just don’t know how to put a valuation on it, so I’ll give it a miss.

Out of fashion

JD Sports Fashion (LSE: JD) shares took a dive on 22 September in response to interim results, and then slid further by the end of the week. We’re looking at a 12-month fall of 50% now.

I wonder if this might just be a return to normality. JD shares did soar during the pandemic, but then went into sharp decline in 2022. Over the past five years, shareholders have seen their investment rise by 40%, though the price is back at mid-2019 levels now.

The company’s outlook is upbeat, with early sales in the second half around 8% ahead of the previous year. JD also notes “an encouraging return to positive trading in the United States“.

Forecasts suggest a forward price-to-earnings (P/E) ratio of under 10. There’s certainly risk here, as first-half profits were weak. And a recession ahead of us won’t help.

But I find the valuation attractive, and I’ve put JD Sports Fashion on my list of buy candidates.

Cheap land?

Land Securities (LSE: LAND) had seen its shares slowly gaining in 2021. But 2022 has been less kind, as the price slid. The real estate investment trust (REIT) released an operational update on 21 September, and the market didn’t like it. The shares dipped further, and have now lost nearly 25% of their value in the past 12 months.

With the REIT now down to levels not seen since the worst of the pandemic, I’m adding it to my list of buy candidates too.

Forecasts put the dividend yield at over 6% this year. And Land Securities has a solid track record of annual dividend raises. Whether it will be able to continue that throughout the coming recession is the big risk. And if the dividend is reduced, I can see the shares falling further.

But I see a healthy long-term future for the property rentals business, and I intend to examine this one more closely.

While I don’t own any shares, I’ve been bullish on this business for the past few years. So is this a case where short-term problems are dragging down a potentially excellent company? Or is my theory broken? Let’s take a closer look at what’s going on.

What happened to this FTSE 100 stock?

The Ocado Smart Platform (OSP), its business-facing robotics warehouse automation solution, has been performing admirably. This part of the business was the primary focus of my investment idea and now has 11 industry-leading partners in nine counties worldwide, with 16 customer fulfilment centres on-line.

As per the latest interim results, revenue from the group’s international OSP has more than doubled. Meanwhile, fees generated from its UK Logistics operations grew by 8.9%.

As more companies seek to cut costs, the ability to automatically process and prepare customer orders is growing in demand. And based on the performance delivered so far, Ocado seems to be hitting the mark. So why is this FTSE 100 stock being sold off?

The problem lies with its retail division. Despite heavy investments into robotics, Ocado is still first-and-foremost an online grocery store. At least on a revenue basis. And since the height of the pandemic, growth has consistently failed to meet expectations.

After lockdowns were lifted, consumers began venturing back to brick & mortar stores. As such, the company lost its tailwinds and couldn’t hold onto all of its newly-secured market share. This downward trend in growth continued throughout 2021. And now, in 2022, with inflation driving up prices, customer spending is still falling.

The online store continues to attract new customers with a total of 946,000 active members. And this has driven the average weekly orders up. But with inflation placing pressure on spending, basket sizes have been dropping, causing revenue to decline. Pairing that with widening losses from rising costs, and the result is a massive drop in the Ocado share price.

To buy or not to buy?

As a platform, Ocado looks superb, in my opinion. The rising customer count on both sides of its operations proves it has something valuable to offer. And with more members joining its ecosystem in a post-pandemic world, it’s clear that this wasn’t just a Covid stock.

However, as a business, Ocado has a long way to go. The international OSP is making solid progress, in my mind. But it remains a tiny part of the overall operation, only contributing 4.6% of the revenue stream. And with rising dry ice and electricity costs, the path to profitability seems to be getting even longer.

In the long term, I continue to believe Ocado can become one of the best-performing FTSE 100 stocks. But a lot has to go right for this to become a reality. For now, I think it’s worth moving this stock back to my watchlist until a shorter path to positive earnings materialises.

Ocado shares are a long way from their all-time high of over 2,900p during the pandemic. So are we looking at a screaming buy now?

We had an Ocado Retail profit warning on Tuesday. Ocado says it now expects “a small sales decline in FY22 and close to break-even EBITDA“.

Customers are feeling the cost-of-living squeeze and buying less. Shopper numbers are up 23%, but the average order dropped 6%.

M&S down too

Ocado Retail is run jointly by Ocado Group and Marks & Spencer. M&S shares also declined, losing 7% since the update. M&S has fallen 36% in the past 12 months.

I think the latest disappointment hides a bigger underlying problem.

Ocado was a bit of a growth share darling, even in the years leading up to the pandemic. And then when Covid arrived, it almost went into orbit. The online shopping revolution had just received a massive boost, and Ocado was one of its pioneers.

That alone though wouldn’t justify the soaring growth share price for me. After all, it’s still just grocery shopping, and the total amount people eat isn’t going to rapidly expand. You still need warehouses to store all the stuff, and margins aren’t much different.

Technology

No, the growth spurt was all about technology. Ocado isn’t just a supermarket. It also has the technology needed to manage online shopping — logistics, software, the lot. Supermarkets around the world wanting to expand online can get the whole startup package direct from Ocado.

In my mind, this just created confusion. Am I looking at an online supermarket that’s being priced as a high-tech growth share? Or is it a high-tech growth share that isn’t even earning the profits of a supermarket?

That’s the core issue, profit. Or rather, no profit. Even during the advantageous pandemic lockdowns, Ocado was still unprofitable. And it’s been raising more new cash this year.

That means I have absolutely no idea of how to put a fair valuation on Ocado shares. And even if I did, who knows what further dilution shareholders might face before they can pocket their first profits?

Customer expansion

What will happen next? There’s surely still some pretty big potential for online groceries expansion around the world. And at the halfway stage this year, it looked to be going well.

Ocado had 16 customer fulfilment centres live with partners around the world. And it spoke of 11 new partners in nine countries having newly signed up. It’s been making what sounds like promising progress in improving its offerings too.

On the financial front, the company doesn’t expect to need any further financing in the mid-term, “as the business becomes cash flow positive“.

Right now might turn out to be a good time to buy cheap Ocado shares, ready for steady growth once conditions normalise. So will I buy? Nope. Not until I see that cash flow and can work out a fair valuation.

Tough times

It goes without saying that the last few years have been particularly tough for airlines. Following the grounding of flights due to a global pandemic, we now have a cost-of-living crisis squeezing incomes and, consequently, the ability to travel.

I don’t doubt there are better times ahead. However, I very much doubt I’ll ever own a stock like International Consolidated Airlines (LSE: IAG), even if I had free cash to do so.

Now don’t get me wrong — there are things to like here. The company boasts some of the most recognisable brands in the business, including British Airways. And we could see a ‘short squeeze’ if the company releases even a slightly better-than-expected update in the near future.

Debt-laden

But let’s not beat about the bush. Even as weaker airlines fold, the sector will remain hyper-competitive. With fewer people travelling for business, I reckon IAG faces an even greater fight for flyers than before. There are a raft of other issues that all carriers must contend with too, including staffing issues and volatile fuel prices.

Sure, no company’s earnings are completely safe, but I’d much rather own, say, a consumer goods firm where growth isn’t dependent on quite so many factors working in its favour.

On a more fundamental level, IAG now carries a truckload of debt. For this reason, I wouldn’t expect anything significant in terms of dividends for quite a while.

IAG could certainly make me money once the dark economic clouds disperse. Would I want to leave money here with so many other companies on a more solid footing? I don’t think so.

Not on my shopping list

I’ve also been bearish on Ocado (LSE: OCDO) for years now. Up until the beginning of 2021, that looked like an exceptionally bad call. Its stock soared in value as the company penned more contracts with retailers for its impressive logistics tech. Since then however, it’s been a very different story.

Ocado’s share price is down roughly 75% from its record high. That’s severe. But I don’t think it’s unjustified.

Inflation victim

As always, the market has been looking ahead. In addition to increasing costs incurred by the company, the jump in inflation means some shoppers will have switched to cheaper rivals. Worryingly, there could be worse to come with price rises expected to hit 14% in Q4 this year.

More generally, the exodus from growth stocks on concerns over rapid interest rate rises was never likely to leave Ocado unscathed.

Again, it’s not all bad. Ocado could recover strongly when risk appetite returns. It can sometimes be that this year’s most hated shares are next year’s most popular.

Even so, it will take a while before its logistics division contributes to the top line to the same extent as its retail arm. In the meantime, we have an unprofitable company that, again, isn’t about to pay me a dividend.

Given the chance to invest free money, I think I could generate a far better return by looking elsewhere.

Inflation woes mounting

Over the past few weeks, nothing material has changed at Ocado. Rather, the main driver for the push lower is what’s going on in the broader economy.

UK inflation hit 10.1% in July, with the figure coming out after the H1 results. Within the results, I noted the concern that the business had around cost inflation. If that was a worry it had back when the report was being written, it’s only going to be worse now. Not only that, but expectations for inflation are now even higher for the next six months.

So I think investors are clearly worried about how future inflation is going to mean Ocado making a smaller profit margin from the retail division. Or if it puts up the price of groceries, it could lose out on customer business.

Even for the logistics arm, inflation is a headwind. It mostly services other companies in the same sector, all of which will be feeling the pinch from higher prices too. This could mean a reduction in the usage of the service going forward.

Heavily reliant on retail

While Ocado is making good progress with the UK and international solutions and logistics arm, the retail side of the business dwarfs it. For example, in H1 the former generated around £453m in revenue, the latter £1.12bn.

For all the good work being done, I feel Ocado is very exposed to a fall in consumer demand from the retail division. Customers are really starting to feel the pinch with the cost-of-living crisis. Switching grocery shopping to a cheaper brand is something that I think many will do.

Given that Ocado can’t offset this potential dive with other areas of the group, I don’t think the outlook is great. The fall in the share price last week makes me think I’m not alone in this thinking.

Value in Ocado shares

Some could argue that now is a good time to buy, citing that the business is undervalued. The fact that the firm is losing money means I can’t use a conventional price-to-earnings ratio to compute this. But any stock that has lost 65% in a year could be a smart long-term play.

Further, if inflation does peak this winter and then normalises early next year, Ocado could ride out the storm. It’s only a medium-term issue and isn’t something that fundamentally invalidates the business model.

Yet ultimately, I still can’t get excited about the prospects for the business, so won’t be investing.

I’ve been taking a look at the biggest FTSE 100 fallers so far in 2022. Are there any bargains on offer for investors ahead of a possible market recovery?

#1: Ocado collapse

Online grocer and warehouse specialist Ocado Group (LSE: OCDO) has fallen by more than 50% since the start of the year. It’s been a painful collapse, but with the company’s international business still growing, is there an opportunity here?

Ocado’s latest numbers don’t tell a great story. Revenue fell by 4.4% to £1,262m during the first half of this year and the group reported a pre-tax loss of £211m.

UK shoppers are scaling back their online ordering after the pandemic and maybe finding cheap places to shop.

However, it’s the international business that matters here. Ocado is selling its automated warehouse technology to retailers around the world. The company builds the warehouses for its customers and then collects a percentage of future sales.

This business is losing money at the moment. But Ocado’s management believe that future profits could total more than £750m over the “mid term”.

That could make Ocado shares look cheap — one day. Personally, I’m not comfortable with the long timeframe and the company’s continuing losses. I won’t be buying.

#2: Admiral could be a bargain

Shares in FTSE 100 insurer Admiral (LSE: ADM) have fallen by more than 40% so far this year.

A sharp rise in car repair costs is putting pressure on all motor insurers’ profits at the moment. Admiral’s profits are expected to fall by around 25% this year.

The main risk I can see is that competitive pricing in the insurance market will leave Admiral struggling for a while yet.

However, Admiral has a long track record of steady growth. It’s always been highly profitable and very well managed, in my view. I think this will probably still be true in the future.

The latest broker forecasts suggest that Admiral is trading on around 13 times forecast earnings at the moment, with a potential 7% dividend yield.

Although the short-term outlook is uncertain, I think Admiral shares probably offer good value as a long-term investment.

#3: JD Sports needs a new boss

Shares in sportswear retailer JD Sports Fashion (LSE: JD) are still worth 1,750% more than they were 10 years ago. But the company’s share price has fallen by more than 40% so far this year, despite record profits.

What’s knocked JD Sports down so low? The company has run into problems with UK regulators and decided to part ways with long-time boss Peter Cowgill.

JD is still hunting for a new chief executive. But what interests me is that management believes the group can match last year’s record profits this year, despite tougher economic conditions.

If this view is correct, then JD Sports shares could be trading on just 10 times forecast earnings today. That would be cheap, for a market-leading retailer.

I think there’s going to be extra uncertainty and risk until a new chief executive is appointed. But, in my view, this period of limbo might be an opportunity for long-term investors.