Should I buy after Ocado share price leaps 6%?

Supermarket aisle with empty green trolley

Ocado Group (LSE: OCDO) has always seemed something of an enigma to me. The company started out as simply an online supermarket, at a time when Tesco and the rest were seeing demand for their home delivery services rising strongly.

At flotation in 2010, the shares were strongly subscribed and the price soared way above what seemed to me like a rational valuation.

Admittedly, Ocado doesn’t have the overheads of a large chain of stores to deal with and delivers solely from its warehouses. But I couldn’t see where the profit was going to come from to justify that early share price.

Eight years on, the share price has climbed a lot further. At 1,308p at the time of writing, Ocado shares are up nearly 150% in just the past 12 months, so what’s happened?

It’s down to partnerships, with the firm’s recent tie-up with Marks & Spencer (LSE: MKS) providing a big boost.

New contract

The latest news Tuesday is of another deal, this time with Australia’s Coles Group to develop its online groceries business based on the Ocado Smart Platform. If you don’t know who Coles is, it’s one of Australia’s biggest retailers and already commands online sales of around A$1bn a year.

But Ocado still isn’t making any profit, and there’s none on the cards as far as forecasts go. So how can we justify the lofty share price?

Well, it’s all about that Ocado Smart Platform thing. Ocado isn’t an online supermarket any more, it’s a technology provider — and we all know technology shares can keep climbing regardless of profits. Oh, hang on, I’ve just remembered what happened last time.

Ocado may well prove successful by licensing its technology and its patents, but until there are some profits and some way of quantifying the firm’s value, I’m steering well clear.

Strategy shift

Speaking of Marks & Spencer, that’s another I’ve always seen as somewhat enigmatic. For decades, the company has enjoyed roaring sales in its food division but has struggled to keep up with clothing trends, so it’s focused most of its efforts on the latter — but with little success.

Despite its best efforts, M&S’s earnings have been unexciting, and have actually been falling for the past couple of years. But a 40% share price slump in five years has dropped the stock’s P/E valuation as low as 10, and pushed dividends up to more than 6%. For an investment, you could certainly do worse than that.

But things are up in the air again after M&S announced its tie-up with Ocado, focusing on the part of its business that it actually does best.

Raising cash

The deal involves Marks & Spencer shelling out £750m for a 50% stake in Ocado’s UK retail business, and that will be paid for by a combination of a £600m rights issue and a cut in the dividend.

Something that immediately springs to mind is that M&S is buying into Ocado at a time when Ocado shares are soaring, funded by a rights issue at a time when M&S shares are close to a five-year low — but I guess that’s timing for you.

Would I buy M&S shares now? Not with the new uncertainty. But then, I wouldn’t have bought them before the Ocado deal, not when there are so many better options out there.

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Alan Oscroft has no position in any of the shares mentioned. The Motley DailyCurves UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley DailyCurves we believe that considering a diverse range of insights makes us better investors.

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