Why this small-cap growth stock could trash the Ocado share price

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Ocado Group (LSE: OCDO) shareholders have had a rollercoaster ride over the last year. The retail technology firm’s share price has fallen by about 25% since late July, but the shares are still worth 180% more than they were in October 2017.

This impressive performance has earned the firm a place in the FTSE 100. But even Ocado’s biggest fans would probably admit that most of its valuation is based on hopes of future profits.

Today, I want to take a fresh look at the firm and ask if the stock is safe to buy.

Tech, not retail

Founder and chief executive Tim Steiner is quite clear that he wants Ocado to be seen as a technology company, not a retailer.

Although the firm’s UK retail business now has annual sales of about £1.6bn, that’s a drop in the ocean compared to the £100bn+ of goods sold by the big three listed supermarkets each year. Retail profits are minimal too. They certainly don’t justify Ocado’s £5.8bn market cap.

The real value of the UK retail business seems to be that it demonstrates the potential of Ocado’s software and automated warehousing systems. This is the firm’s real product, which it sells to other major retailers to kick-start their online growth.

Good progress

This year has seen Mr Steiner sign a string of deals with overseas retailers. But it’s worth noting that these deals usually seem to require Ocado to invest a fair chunk of cash in building new warehouses. The company says a new warehouse typically has “peak cash outflow” of £30m, due to the cost of installing the firm’s mechanical handling equipment.

Very little financial detail has been provided about the expected profitability of these deals over the coming years. My impression is that it’s likely to be several years — at least — before we see much in the way of profit.

Analysts expect the firm to report another year of losses in 2019. Shareholders were tapped for £143m of fresh cash in February. I suspect another fundraising might be needed before the firm starts generating a profit.

Meanwhile, CEO Mr Steiner sold more than £100m of this own stock during the summer, while the share price was still over 1,000p. I’d follow his example and lock in some profits.

One growth stock I’d buy

One online growth stock you may not have considered is retailer Findel (LSE: FDL). This firm was historically a catalogue retailer. It now operates mainly online, selling a wide range of toys, gifts, electricals, homewares, budget fashion and much more through its Studio website.

Findel’s other main business is quite different, educational supplies. This operation offers a wide range of products for nurseries and schools. Both businesses are aimed at the value end of the market.

Gaining momentum?

In an update on Wednesday, the company said that sales from the Studio business rose by 8% during the first 28 weeks of the year. Management remains confident it will hit full-year targets for sales and profit growth.

This business has been through a turnaround period over the last few years, but now appears to be on track to deliver rising profits. Although there’s no dividend, the stock trades on a forecast P/E of 10 for 2018/19 and analysts expect earnings growth of 11% in 2019/20.

I believe this stock could be worth further research as a potential growth buy.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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 Fool we believe that considering a diverse range of insights makes us better investors.