Barron’s: This ‘alternative to Amazon’ is up 60% in May — here’s how to play the stock

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If you fire up your computer or phone to get your groceries, there’s an increasing chance you might rely on British online supermarket Ocado Group’s technology. That’s thanks to the company’s big deal with U.S. supermarket giant Kroger this month, which comes after negotiating other partnerships around the world.

But with Ocado’s shares OCDO, +1.46% having soared roughly 60% in May, you might not want to bank on the stock. Even some fans are suggesting it’s time for shares to digest their Kroger-driven pop.

“We think there is a great deal for management to now execute on, and thus see a low likelihood of another major deal in the near term,” say RBC analysts led by Sherri Malek in a recent note. They put a price target of 7.50 pounds ($10.04) on the stock along with a Sector Perform rating, saying it’s already “fairly valued” and implying it will drop 14% from a recent £8.70.

The pact with Cincinnati-based Kroger KR, +0.20% calls for the U.S.’s largest supermarket chain to raise its stake in Ocado to more than 6% and to license the U.K. company’s technology, which facilitates deliveries and warehousing. It’s a “transformation licensing deal” that has “squashed skepticism about the validity of Ocado’s solution for online grocery retailing,” write Malek and her colleagues. Ocado, founded in 2000 by three former Goldman Sachs bankers, has a two-pronged business model, selling groceries directly to people, while also licensing its technology to other companies, including French retailer Casino Guichard-Perrachon CO, +0.15%  , Britain’s Wm. Morrison Supermarkets MRW, +0.41%  , and Canadian grocer Sobeys, which is owned by the Empire EMP.A, +1.57% conglomerate.

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The market loved the Kroger deal, sending Ocado’s stock up by 44% on the day the agreement was unveiled — May 17. Traders said a short squeeze added to the surge.

Now comes the tricky part. The Kroger deal and other recent agreements have left management with a lot to do, the RBC analysts note. “While Ocado’s solid operational track record gives us confidence in management’s ability to execute, the large number of projects occurring simultaneously does present a greater degree of execution risk than previously,” they write. The analysts “generously assume” that nine other sizable deals will be signed over the next decade, but estimate Ocado won’t see positive free cash flow until the 2022 fiscal year.

And that relates to another challenge for bulls: The company’s valuation is along the lines of caviar rather than potato chips. FactSet’s figures put Ocado’s price/earnings ratio above 5,000. There is no multiple from FactSet for forward-year estimated earnings, because Ocado isn’t expected to turn a profit in 2018 or 2019.

To be sure, some bulls see the stock running higher in the year ahead. Ocado, based in Hertfordshire in southern England, has “developed a credible and profitable alternative to Amazon’s AMZN, +0.44% threat,” say Bank of America Merrill Lynch analysts in a recent note, as they put a Buy rating on shares along with a price target of £10.20, implying a rally of about 17%. Enthusiasts also have highlighted how Ocado’s stock, part of the mid-cap FTSE 250 MCX, +0.58%   , could enjoy a lift if it’s promoted during the coming week as expected to the blue-chip FTSE 100 UKX, +0.18%  , as part of that equity index’s regular reshuffling.

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But it might be prudent to use Ocado for fruits, vegetables, and other groceries, rather than for boosting your portfolio’s performance.

This report also appears at barrons.com.