Food retailer OCDO (Ocado) recently published its 2013Q4 results, which saw sales up 20%. It collaboration with Morrisons is starting to bear fruit. There is considerable price momentum in the company, and bears are, understandably, probing for weakness to see if it’s a good shorting candidate.
Personally, I think £400m would be a more realistic valuation for OCDO, and I expect that many think it should be lower still. Even if I put on my Fantasy Hat I could only come up with a valuation of £1400m; less than half of its current valuation at £3.1b.
How did I arrive at that figure? By being really lazy and optimistic! I assumed that it could do about £4b in revenues in about 10 years. That may sound a stretch, but OCDO is growing its revenues by around 16%pa. So, it could potentially quadruple sales over 10 years. If it could earn a 3% net profit margin on that, it would be earning around £120m in a decade’s time. Slap on a pricing multiple of 15, and discount that over a decade at the risk-free rate of about 2.9%, and you come up with a valuation of about £1400m (~ 120 x 15 / 1.029^10). See, I told you I was being lazy!
I have, of course, made a vast array of assumptions which many can pick apart as laughable. The most egregious assumption I think I’ve made is that I have I am assuming that OCDO can fund expansion without tapping shareholders. That’s a big assumption, and would imply that OCDO was even more overpriced if that assumption proved to be incorrect. Deutsche Bank recently noted, for example: “Ocado’s margins were already so low that any additional investment would revive cash flow concerns”.
Digital Look reports that 2 brokers rate OCDO as a strong buy, and 5 as a strong sell. Goldman Sachs is their corporate broker, the directors have strong links with them, and, given the expansionary nature of the company, I would expect it to be a nice little fee-earner for the Goldman. Needless to say, they rate OCDO a buy. Digital Look may be a little outdated, though, as I think that Numis downgraded it yesterday from Buy to Add. I’m not sure where Numis are coming from with their recommendation. Maybe they just let the trend be their friend, flip a coin, or something.
Personally, I think what bulls are missing is that OCDO is, at the end of the day, a simple distributor. And, despite having some cachet as an internet stock, its business model isn’t scalable like an internet stock. With internet stocks, you have high returns on capital, and when you need to scale up, you phone up IBM and order an extra server (OK, OK, I’m simplifying here). With OCDO, you actually need warehouses.
It will be interesting to see how this develops. Will momentum win out, or will the shorts finally have their day? Be forewarned, though, that the Morrison’s deal is likely to keep feeding growth into the figures for next quarter, so it’s not a done deal that the momentum trade is dead. Sentiment could still be strong. All IMO, and to be taken with a pinch of salt.