Down 50%: is it time to buy Ocado shares?

Ocado (LSE: OCDO) shares tumbled on Tuesday, after the company reported disappointing Christmas sales results, and said its grocery retail business would return to profit. “close to break-even” in 2023.

Although Ocado shares have bounced back from lows seen in October, the stock still fell by 50% over the last year.

After a sharp decline, Ocado shares are trading at levels previously seen in 2018. However, the business has made significant progress since then, selling its automated warehouse technology to several large retailers.

What is this FTSE 100 is the show now starting to look like a contrarian buying opportunity? I have taken a look.

What’s wrong?

Ocado’s grocery retail operation is a joint venture with Marks & Spencer. Tuesday’s numbers showed that online sales rose by just 0.3% to £549m during the final quarter of last year.

Due to the impact of the price increase, this means that the sales volume decreases. Ocado admitted that the average number of items in each order fell by 8.3% to 45, compared to the same period in 2021.

In contrast, both Tesco and Sainsbury’s reported sales growth of around 5% in the latter part of last year.

The figures wrap up a poor year for Ocado Retail. The company said revenue for the whole of 2022 was down 3.8% to £2.2bn. This is the first fall in the company’s history.

The underlying retail profit for the year is expected to be “close to break-even”. City analysts had previously expected a figure of around £35m.

Forget retail, technology is the attraction

With grocery sales of just over £2bn, Ocado Retail is too small to challenge the big UK supermarkets. Sainsbury’s annual sales are around £30bn, for example.

The real opportunity for Ocado shareholders is the group’s technology division. It provides a robotic warehouse system for other retailers – known as the Ocado Smart Platform.

The company has signed on several major foreign retailers as clients over the past few years. This includes US retail giants Hook and recently the South Korean firm Lotte Shopping.

In the presentation last November, Management said that the technology business now has a “clear path” to generate more than £1.1bn in costs per year, over the medium term. The profit margin on this income can be up to 70%, according to the presentation.

If Ocado can deliver on that promise, then I think the stock could be cheap at current levels.

My concern is that profits will always be seen many years ahead. In the meantime, Ocado needs to keep spending, in order to build customer warehouses and expand its own UK facilities.

Ocado shows: what I will do

Ocado fans say that this business can be like Amazonwho lost money for 10 years before becoming profitable.

This may be true. But even if there is, investors should remain patient. Forecast Brokers suggest the group will report a loss around £350m in 2023, and £245m in 2024.

Based on this insight, Ocado’s £6.5bn valuation still looks too expensive to me. Unfortunately, I still see this as a stock to avoid.