Should I buy shares in Ocado Group?

Shares in Ocado Group added over 5% on Tuesday, after news that the online food retailer had appointed Sir Stuart Rose as chairman with effect from its annual general meeting on 10 May 2013.

Lord Grade will retire as a non-executive director and chairman on that day.

"Best possible hands"

"I am leaving the company in the best possible hands," Lord Grade commented, adding that Sir Stuart's "substantial retail experience and commercial acumen" would add significant value to the company.

Investors will fondly remember Sir Stuart as the man who, during his six-year tenure, turned around Marks and Spencer, halting a decline in sales by jazzing up its clothing range and leaving the brand in a much better state than when he inherited it. Within three years, he lifted operating profits from £824 million to more than £1 billion - M&S's highest profit since the late 1990s.

However, he was also criticised by some shareholders for hefty pay and breaches of corporate governance guidelines as he occupied both the chief executive and chairman roles at M&S.

"We think that criticism of Sir Stuart at M&S went too far, that he is a good team player and external communicator, which should therefore be of great assistance in sorting out Ocado's Pravda-like approach," commented Philip Dorgan, analyst at Panmure Gordon.

"Generally, appointing an 'outsider' is a good thing in a troubled company," he added, although he pointed out that Ocado has had no shortage of external voices on the board, with six non-executives (plus the chairman) as of the last report and accounts.

Shore Capital's Clive Black was more sceptical of Sir Stuart's appointment; not because of his capabilities, but because of the challenges faced: "We are delighted to see Sir Stuart back in the sector. However, the evidence tends to suggest that bad companies will always beat good management."

Takeover target?

Sir Stuart's appointment fuelled speculation that the online retailer was once again on M&S's radar. He was widely reported to have eyed an acquisition of the online grocer before it floated on the London Stock Exchange in 2010, but walked away from negotiations over numbers "not adding up".

Dorgan also pointed to Morrison Supermarkets as a potential buyer: "There has been a fair amount of bid chatter surrounding Ocado shares of late, with Morrison's gaping gap online in food seen by many as an obvious home." However, he also added that "a deal at current prices is very unlikely".

The ASOS of food?

The appointment comes during a crucial year for the loss-making online grocer. Pre-tax losses are forecast to widen to about £12 million this year, with the company facing multiple challenges, including capacity constraints and weak consumer demand.

Still, Sir Stuart believes Ocado has the potential to become the "ASOS of food", in reference to the online fashion retailer that has seen its share price rocket more than 600% since its listing in 2008.

"I have been very impressed at the impact and progress Ocado has made to date," commented Sir Stuart. "As retail goes through a fundamental shift into the digital world, I believe Ocado's model and the high standards of customer service it provides will see it emerge as a powerful online player."

Ocado has polarised investors.

Bulls point out it is close to opening a second distribution centre in Warwickshire, nearly doubling its capacity. Some analysts say this move will be pivotal to helping the company compete against rivals such as Tesco, which opened its fifth "dark store" on Monday, serving only online customers.

Fans also note the rapid growth in online grocery sales (gross sales in the run-up to Christmas had improved 14%) and high customer service ratings.

But bears say its model of filling orders from central depots will never be as profitable as online operations at established grocers, which are seeing faster online sales growth than Ocado. Tesco, for example, offers shops, online delivery and the compromise, "Click and Collect".

"We see the rise of Click & Collect in particular at the major supermarkets and Waitrose's (John Lewis Partnership) stellar online progress as material challenges for the group, one that must effectively commission and operate a new fulfilment centre in the very near future," said Black.

In fact, Ocado is yet to make a profit, 11 years after it first opened for business.

"[Ocado's] multichannel competitors are growing faster and profitability seems to be nowhere in sight," Dorgan stressed, adding that the online retailer "gobbles up cash" - in November, Ocado raised £36 million in a share placing that allowed it to agree a vital refinancing with banks on £100 milliom of debt used to pay for the new distribution facility. And a recent update from the online delivery group indicated net debt of £93 million and plans for near-term capital expenditure of £46 million.

Ocado also has a long track record of over-optimism with regard to assessing its own prospects.

"The business model is just not working," stated Black. "The cost of competing and the cost of fulfillment are just too high; hence it makes meagre cash flows and no earnings never mind dividends."

Jonathan Pritchard of Oriel Retail echoed this view: "The fundamentals are very poor here (losing market share, strategic lack of click and collect, pressure from Waitrose) and any further strength in the shares will offer a very good opportunity to exit."

Shares in Ocado have climbed more than 50% over the past six months.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.