3 reasons why I think the Tesco share price holds far more appeal than growth stock Ocado

The Motley Fool
Supermarket aisle with empty green trolley
Supermarket aisle with empty green trolley

Shares in online grocery retailer Ocado(LSE: OCDO) were in positive territory as markets opened this morning following the publication of its latest trading update an hour earlier.

Despite having performed magnificently over most of 2018, I’m still wary of the stock. Moreover, I think industry peer Tesco is a far safer bet.

Before giving my reasons for this, let’s take a closer look at those numbers.

Just the beginning

Revenue from Ocado’s retail operations rose 12% to £390.7m over the 13 weeks to 2 December, in line with the company’s own guidance.

While the average order size fell by a single percentage point to just under £105 over the last quarter, the average number of orders was 13.1% higher at 320,000. Given this, it’s positive that the company also reported that its new facilities in Andover and Erith were performing well with the latter allowing the company to process over 30,000 orders per week.

Reflecting on today’s figures, CEO Tim Steiner said that Ocado’s story had “only just begun” and that the company would continue to pursue its “substantial opportunities” over the next year.

This all sounds very encouraging. So, what’s my beef with the company, you ask?

1. Valuation

Regardless of just how good its technology is, the ‘jam tomorrow’ nature of a company like Ocado means it’s always worth questioning whether this promise is already priced in.

With a market cap of over £5.5bn, I’d say this was very much the case, even if the firm’s shares are now around 30% cheaper than they were back in late July.

Don’t get me wrong: the signing of a number of deals with larger retailers such as US giant Kroger was clearly great news. The dramatic reduction in interest from short sellers is another indication of how much the market has warmed to the company.

Then again, no business is worth overpaying for. To me, shares in supermarket juggernaut Tesco look far more attractively priced.

As a result of the recent market sell-off, stock in the Welwyn-based business can now be bought for 14 times expected earnings. That’s not screamingly cheap but it does seem reasonable for a market leader.

2. Ongoing investment

In contrast to earlier years, Ocado also has far more cash on its balance sheet (£411m) that it used to. Nevertheless, one should not underestimate the substantial investment required for it to become the “Microsoft of retail” that some are suggesting. As a result, I maintain that it could be a long time before the firm reports a profit.

The need to fund this expansion also means that the company could look for further cash injections from its investors. That’s to be anticipated when buying a promising market minnow but it’s not something I really expect from a top tier company.

3. Dividends

Rounding things off, the resumption of dividends in the current financial year is arguably another reason to favour the £19bn cap over Ocado.

Yielding 2.6% at the current share price, Tesco might not be a dividend bonanza compared to other FTSE 100 firms but the payout is forecast to grow by 47% in the 2019/20 financial year. The fact that this cash return is likely to be covered well over twice by profits also makes it far more secure than many of the index’s more generous payers.

In sharp contrast, Ocado doesn’t return anything to its shareholders.

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