Ocado Group (LSE: OCDO) published its results for the year ending 1 December 2014 today, revealing a post-tax profit of 7.2m the firms first annual profit in its 15-year history.
Unsurprisingly, markets have reacted positively to the news, and the online supermarkets shares are up by around 6% as I write.
Morrisons saves the day
Ocados 25-year, 200m deal to provide an online delivery service for Wm Morrison Supermarkets (LSE: MRW) was a key factor in last years results.
The deal resulted in 45.1m of fees and costs being charged to Morrisons last year, and increased Ocados post-tax profit by around 50%, based on my calculations.
Despite this, its worth noting that Ocados first full-year profit fell significantly below expectations the latest consensus forecasts indicated a post-tax profit of 12.9m, 79% more than the 7.2m reported today.
Is Ocado a safe buy?
Sadly, Im not convinced that Ocado is a safe buy at todays share price. In my view, the firms valuation simply doesnt make sense when compared to those of other supermarkets.
Ocado shares are currently trading at 346 times 2014 earnings, yet Ocados 1.7% operating margin suggests it is unlikely to be more profitable than regular supermarkets, despite the boost provided by the Morrisons deal.
Indeed, its reasonable to argue that all the main supermarkets could report operating margins of 1.5-2% over the next year or so.
Given this, its interesting to note that while Morrisons trades on a price to sales ratio of around 0.25, Ocado trades on a price to sales ratio of 2.6. This implies that Ocados sales are more valuable than those of Morrisons but I cant see any reason for this.
Heres the problem
Despite being an online business, Ocado cant scale cheaply: it employs a lot of people and has high distribution and logistics costs.
Ocados total distribution and administrative costs rose by 25% last year, but sales only rose by 15%.
One reason for this might be that Ocado created 1,800 jobs last year nearly double the 1,000 people it was expecting to hire. In 2015, the firm expects to employ another 2,500 people.
Ocado is also dangerously dependent on other, much larger businesses both Waitrose and Morrisons might decide to use their muscle to negotiate better terms from Ocado over the next year.
In my view, Ocado rates as a sell its simply too expensive and is unlikely to provide a reasonable return for investors at todays price.
I believe there are far better growth opportunities available elsewhere in the market, and would urge you to take a close look at “7 Simple Steps To Seeking Serious Wealth“ if this is something that interests you.
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