Ocado Group PLC (LON: OCDO) shares have not done well of late. They did very well indeed during lockdown as all realised that warehouses were the future of retail, not shops. But that effect has faded and Ocado shares have given up all their gains. Today Ocado is up 1% or so on the back of an announcement of an expansion of the agreement with Groupe Casino in France.
The standard view of Ocado is wildly split. There are those who insist that the investment levels in robots and warehouses are excessive. That continuing to plunge ever more capital into such infrastructure just isn’t going to pay off. Or, perhaps, we could call this the short termist view – we’d like some profits and we’d like them now, please.
The other argument is that this is just what is necessary. We’ve a new technology here – those robots and warehouses – and capital investment is what is required. Once the estate is built out then it’ll return vast rivers of cash. But it does have to be invested in and built out before that will happen.
This second view could be called the “Amazon Strategy”. For it is indeed similar to what Amazon did for near the first 20 years of its life as a company. Here’s a new sector. We can trade in it and make margin – which Amazon did. But every scrap of money that came in was used, immediately, to expand the capacity of the network. It was a standard observation that Amazon kept growing but never made any money. The more perceptive noted that it never declared profits because that incoming gross or net margin had been spent on more warehouses, or bigger computers, or other capital investment in building out the system before year-end.
Which is the strategy that we could ascribe to Ocado as well. There’s a landrace going on to be able to build and run the warehouses that will be the backbone of the grocery and shopping business of the future. It could be robots and warehouses, as Ocado is doing. Might be hyperlocal delivery systems from local shops, that’s a bet still to be resolved. But if it is going to be robots and centralised warehouses (the capital costs of robots mean automation only works at scale). There is in fact margin at current operations. Not investing in growing the network could well produce profits. But, as with Amazon, perhaps using all and any cash to expand the corporate infrastructure is the best way to maximise shareholder value?
Which is what that comparison between Amazon and Ocado is. Take current revenues and optimise for profits? Or use current revenues to continue to fund expansion? The speculation, or trading position, is that further investment will be successful and that, at some future date, the market will be conquered and then the profits will really flow.
Now, whether it will actually work or not, that’s another matter. But that is the consideration when trying to price Ocado’s shares.
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Tim Worstall is a freelance writer specialising in economics and the financial markets.