Ocado shares have halved. Why am I still not buying?

Supermarket strategy offer a ‘buy one, get one free’ deal to many people. Now, I can do the same with online retailers Ocado‘s (LSE: OCDO). Specifically, after the 50% drop, I can now buy two Ocado shares for the price I would have paid for one 12 months ago.

Could it be a good recovery play for my portfolio?

Ocado Value

I don’t think so. In fact, I wouldn’t touch Ocado shares with a bargepole. That’s why I don’t like investing in these companies.

The investment case rests on the idea that Ocado is developing a technology-driven platform that enables online grocery shopping for large customers in different global markets. I think this is what has led to a market capitalization of almost £6bn.

After all, even though Ocado has its own retail operations, sales in the first half made £1.1bn. Not only does it represent an 8% decrease from the previous year’s period, but only 4% from the same amount (excluding VAT and fuel) in leading grocery stores. Tesco during the first half of the financial year. Tesco actually generates more from its retail operations in free cash flow than Ocado in revenue.

Even so, Ocado’s market capitalization is 33% that of Tesco. I think this reflects the fact that most investors do not value Ocado as a retailer, but as a solution provider for online shopping.

But that part of the business is unproven, in my opinion. Overall, it looks smaller in revenue than Ocado’s retail business – and a lot of lossmaking. Last year, on total business, Ocado made another £186m loss.

Bull case

The solution business can eventually become a powerful player. The demand for online retail is increasing. Retailers are looking for proven management and logistics solutions that work instead of reinventing their own wheels.

Ocado’s client list includes international retailers such as Hook and Coles, so the approach appears to be gaining traction. In November, the company announced a deal with a large retailer Lotte in the highly competitive Korean market. This is yet another proof that the platform has great potential.

A cost-effective business model

However, my concern is the business model. Ocado doesn’t just sell software. It builds a repository for client services. This requires high capital expenditure, which I think can drag down profits for years or even decades.

This week’s trading statement showed retail profits were down last year, but the bigger concern is the solutions business model. This includes substantial long-term financial outlays for clients on a client-by-client basis. So unlike technology models such as Shopifyplatform scalability here comes at a significant marginal cost.

Should I buy Ocado shares?

Therefore I have no plans to add the company to my portfolio. Although the retail business is starting to fire on all cylinders, I think competitors like Tesco have better value stocks.

Meanwhile, the solution part of Ocado’s business for me is like a money pit for the foreseeable future. It can make big profit in future. However, so far, I don’t see it – or Ocado shows it – as attractive.