Ocado (LSE: OCD) has been working hard to supply food to its customers, but it hasn’t delivered much for shareholders lately. In fact, the Ocado share price is down 40% since January and has fallen 22% over the past year, as I write.

With an expanding client base and growing use of online shopping, can the Ocado share price recover? Or might it fall further?

Start-up economics

Ocado has been around for a couple of decades, so I wouldn’t classify it as a start-up. However, it seems to have some economic characteristics of one. It has been investing heavily to build its business, in the hope that once it is established, costs will fall and revenues rise.

That has cost a lot. Last year, Ocado reported a post-tax loss of £70m. In fact, it has been loss-making for most of its history. It did record a profit for several years, but not since 2016. On the positive side, the company has continued to grow its business strongly. Last year’s revenue of £2.3bn was 33% higher than the prior year. Many retail businesses or even tech firms would love to see that sort of growth.

Ocado’s long-term plan

Will the company’s years of heavy expenditure pay off in the end?

The bull case for Ocado points to the fact that the company has developed expertise in the mechanics of online commerce, from the user interface to automated warehouses. That has helped it snag some impressive retail customers globally, from Kroger to Morrisons. The company sells products through its relationship with Marks & Spencer. But what excites many investors is the potential to roll out its technology platform to a lot of new customers. If marginal costs fall with such expansion, the company could become profitable.

But I see a couple of difficulties with that logic. To service orders, Ocado has been building warehouses serving specific customers. That is a substantial capital expenditure. Many tech companies scale their platforms without having to spend a lot more money — but that might not be the case at Ocado. Additionally, many companies have developed expertise in online commerce handling and fulfilment, including THG and Next. That makes me wonder whether Ocado has a compelling competitive advantage or is simply one more player in a marketplace that could end up being focussed on price.

Will the Ocado share price recover?

Even after the falls, Ocado has a market capitalisation close to £14bn. That is a substantial amount for a loss-making business, in my opinion.

To justify such a beefy price tag, I think Ocado needs to inspire confidence in its future prospects. Personally I have my doubts. Growing its business with new clients may call for it to keep adding new infrastructure. Such capital expenditure will increase costs, which could make profits even more elusive at the firm. For a loss-making company looking at large costs in years to come, I think £14bn is a heady valuation.

If it can show that its business model will allow it to add new customers without incurring substantial costs in future, I think the share price could recover. But I also think that might not happen. That’s why I wouldn’t add Ocado to my portfolio, even at its current price.  

The post The Ocado share price has fallen 40% since January. Can it recover? appeared first on The Motley Fool UK.

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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Morrisons and Ocado Group. 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.