Ocado share price spiked: 3 reasons acquirers should avoid it

Ocado (LON: OCDO) share price jumped by more than 40% on Thursday as investors cheered rumours of a potential bid for the company. It surged to a peak of 630p, the highest level since November last year and then pulled back to 570p. 

At its peak, Ocado was about 83% above the lowest level this year, making it the best-performing company in the FTSE 100. Here are the three top reasons why Amazon or any other company should avoid buying Ocado.

Ocado Group is still overvalued

Ocado Group has a market cap of over 4.88 billion, which is equivalent to $5.8 billion. While this is lower than its all-time peak of over $10 billion, the company is still vastly overvalued. For a company started in 2000 and with a market value of over $5 billion, you would expect it to either be growing fast or highly profitable.

Ocado is doing neither. Its revenue growth has stalled and the company has struggled to become profitable. Its annual revenue to November 2022 came in at over £2.5 billion compared to £2.498 billion in the previous year. Its retail revenue dropped to £2.2 billion while its total loss widened to over £500 million. 

Therefore, it does not make any sense to pay for a premium for a company that is grossly overvalued. And as shown below, data by FT shows that analysts expect the company’s earnings and profitability growth does not support this valuation.

Ocado is still a cash incinerator

Ocado Group is a mature company that was established in 2000. Therefore, at this stage, the company should be highly profitable. But the opposite has happened. It has incinerated billions of dollars in the past decade. It has also diluted shareholders by selling additional shares to investors.

Ocado spends so much money because of its solutions business, where it builds automated warehouses. Earlier this year, the company said that it will cut costs as it prioritizes profits. Despite this, I believe that the company is on track to burn more cash this year. As such, an acquirer will need to pay a premium for the company and then lose money turning around the firm.

Ocado is a low-margin company

Assuming that Ocado is able to make money, the reality is that it is a low-margin business. According to FT, Ocado’s net profit margin in 2022 was mins 19.15% while its operating margin came in at minus 18%. The gross margin, which is important for a company like this, came in at 38%. This means that its profit margins will not be enticing when it breaks even.

There are other red flags for Ocado. For a company like Amazon, it is unclear whether CMA will allow the deal because of its strong market share in the country. Also, there are issues because of how Ocado operates. It has a joint venture with Marks and Spencer and works with other retailers like Kroger.