It’s fair to say that the share price of Ocado, the UK-based online groceries shopping and warehouse technology growth stock, has taken a battering over the past couple of years. The company has lost 85% of its market capitalisation since its most recent high in early 2021 and is down around 62% in the past 12 months. The share price has declined 35% in the less than 4 months since the beginning of 2023.

The company’s valuation was undeniably inflated during the Covid-19 pandemic when online groceries shopping with home delivery surged in popularity, especially during lockdown periods. A typical ‘Covid stock’ alongside companies like online conferencing tool Zoom and the upmarket exercise bike and fitness class streaming company Peloton, Ocado’s share price was perhaps always destined for a bruising return to earth when it became apparent pandemic trends wouldn’t hold in the post-Covid era.

But Ocado’s business and valuation had been on an upwards trajectory before the Covid pandemic. The company had always struggled to justify its valuation based on the slim pickings of the low margin online groceries sector it helped introduce to the UK market. However, its newer warehouse automation technologies business was showing promise.

Ocado invested heavily in developing proprietary warehouse automation robotics and systems via its Ocado Smart Platform unit. A flurry of deals to build and operate warehouses for some of the world’s biggest supermarket chains followed from 2017-2020, including with France’s Casino Group, Kroger, the USA’s second largest groceries retailer, Canada’s Sobeys and Cole Group in Australia.

Those deals sparked optimism that the Ocado Smart Platform would become the part of the business that would spark growth and finally lead to sustainable profitability. As a result, the Ocado share price gained almost 480% between mid-November 2017 and April 2019. After a period of trading within a relatively tight range just below that late 2019 high, Covid struck and the company’s valuation leapt again, more than doubling between a Covid sell-off low in February 2020 and September that same year.

Those September 2020 heights were nearly touched again in early 2021 but the picture since has been one of almost uninterrupted gloom.

Ocado is now again worth roughly what it was at the beginning of 2018, five years ago. But since then it has seen significant growth in its Ocado Smart Platform business and the online groceries shopping market is worth more than it was pre-Covid, even if less of the sector’s pandemic gains were retained than many expected.

Has Ocado possibly now been oversold and worthy of closer inspection by investors again? Or has a business that has always attracted scepticism about its potential for sustainable profitably simply seen its share price return to fair value after the bursting of a growth stocks bubble?

Why has the Ocado share price dropped so much?

The consistent decline in Ocado’s share price over the past couple of years can be connected back to a combination of a shift in investor attitudes and the company failing to kick on quickly enough after inking its early flurry of Smart Platform partnerships.

As a company, Ocado has always put the emphasis on the future and asked investors to show patience while it invested in establishing a leading market position in online groceries retail – the sector’s fastest growing channel.

When Ocado published its full year results for 2022 in late February, the company again tried to emphasise the growing market it is a major player in, stating of the online groceries segment:

“Online market share has stabilised at materially higher levels following the pandemic [and is more than] 50% higher in the top 20 markets worldwide.”

“Industry data forecasts widespread and continued channel growth. For example, Edge Ascential expects online market share in the top 20 markets, globally, to grow by 30% through 2027.”

Investors, however, are now demanding Ocado starts to show returns sooner rather than later, starting by stemming its huge losses. 2022 saw a pre-tax loss of £501 million. That was not only a huge leap on the £177 million loss recorded in 2021 but also well ahead of analysts’ expectations for £429 million.

More significantly, recent losses form part of a consistent trend. Ocado lost £52.3 million before tax in 2020 and £214.5 million in 2019. 2018 resulted in a £44.4 million deficit.

The structure of its warehouse deals with international supermarket chains always meant that Ocado would have to absorb significant upfront costs before the new revenue stream would start to flow.

The biggest criticism being aimed at Ocado is now the consistency with which it misses financial performance estimates. And not only those of fully independent market analysts but even of its own house brokers, which should theoretically have additional insight.

Ocado’s 2022 losses were accumulated by costs, up 16.5% to £1.2 billion, rising much fast than sales, up just 0.6% to £2.5 billion. There was also £349 million of accounting charges and an almost 14% rise in the cost of the company financing its debt.

However, the biggest worry is now the performance of the company’s UK-focused Ocado Retail partnership with Marks & Spencer. Ocado Retail’s sales fell 3.8% last year to £2.2 billion, which was blamed on the move out of pandemic conditions and the impact of the UK’s cost of living crisis, brought about by decades-high inflation levels.

The silver lining in Ocado’s 2022 results was that the retail business’s total number of active customers grew 13% to 940,000 and the average number of weekly orders placed also showed reasonable growth, up 5.6% to 377,000. Unfortunately, the size of the average order dropped 8.5% to £118, which dragged overall turnover down.

International Solutions, the business unit that sells the Ocado Global Platform into supermarket chains around the world, has also seen growth stall recently after a promising start to signing up international clients. Last year it brought in £148 million, which is only about 50% more than the £100 million in sales the top performing Tesco hypermarkets turn over.

Ocado’s upfront expense in building and fitting out automated warehouses with the Global Platform tech also means the company’s financial situation will continue to deteriorate before it improves. 2023 is expected to deliver another big loss with capital expenditure, up 17% to £797 million last year, expected to remain high. After net debt last year doubled to £577 million a new cash call wouldn’t be a surprise despite £575 million being raised last year through a share issue.

Cashflow tightness has also led to the suspension of new capital investment in expanding Ocado’s network of UK distribution centres, which will have an impact on the growth and efficiency of its retail business.

Has Ocado been oversold?

Despite all of its difficulties, both now and over previous years, Ocado still has a lot going for it as a business. The online groceries channel is growing and is expected to continue to do so, even if growth may not be nicely even over time.

The proprietary technology Ocado has developed does put it in a strong position to profit from that growth over time, across both its UK-based retail deliveries partnership with M&S and its International Solutions business selling that technology into international supermarket chains.

The company’s heavy investment in R&D could still well pay off in the long run. Does that make the stock worth a punt at its current level, despite it being the worst performer on the FTSE 100 over the past 2 years?

It’s a tricky call because Ocado has consistently disappointed investors over the years by missing financial and growth targets and expectations. However, the same could be said of Tesla for many years.

Should companies developing revolutionary technology be held to a different standard when it comes to profitability timelines? Most investors and financial market analysts would say “yes”, but that doesn’t mean growth tech companies have unlimited runway. At some point, profits have to be banked, even if that means reigning in capital investment in R&D and other upfront investments it is hoped will prove ultimately profitable.

Cashflow and profitability are also important, especially during points in the market cycle like the one we currently find ourselves, and investors are clearly running out of patience with Ocado.

It’s hard to make a case for the company’s share price showing clear signs of being oversold on the basis of Ocado’s current business. Any returns at the company’s current valuation will still depend on the company’s future growth and profitability, across both its retail and technology businesses.

I personally believe Ocado stands a fair chance of coming good, but more pain could be on the horizon in the short term. The big question will be if the company has the liquidity to reach profitability without significant dilution of currently issued equity.

I won’t be selling the shares I currently hold in Ocado and would consider acquiring more but not right now. I’ll be keeping a close eye on developments this year, particularly news of new warehouse automation deals being closed in on or signed. That is likely to be the only realistic catalyst to a share price recovery in the next 12 months.