Standing still in turbulent times
Ocado remains mired by its capacity constraints in the retail business. While the Q1 performance was unsurprising, the company is struggling to cope with the sudden spike in consumer demand due to the outbreak of COVID-19. We remain positive on the strength of the business model but one should wait for a better entry point in the stock.
23 Mar 20
Q4 trading update - still going strong
No surprises in the Q4 trading update of Ocado’s retail business. While the capacity constraints are unlikely to go away in the near term, we note that most of the growth is driven by new customer demand in the existing catchment areas. The current momentum is sustainable, in our opinion. No change to the stock recommendation.
16 Dec 19
Ocado enters the Land of the Rising Sun
Ocado has on-boarded Aeon, one of the largest retailers in Japan, under its Solutions business. The deal is not only a pleasant surprise (marks its entry into Asia) but is also valuation accretive. With the UK-based company’s plate (order book) looking quite full, the focus now shifts towards management’s success in implementation. We will increase our estimates upwards and maintain a positive stance on Ocado’s strong business model.
02 Dec 19
Ocado still going strong
Ocado’s sustained top-line momentum is encouraging considering its recent hiccups (the fire at Andover) and the sales headwinds faced by major UK grocers. We also note management’s optimism from the recent on-boarding of M&S in the retail business (and the decision to use this brand as a substitute for Waitrose). We maintain our positive stance on the stock.
27 Sep 19
Moving ahead slow and steady
Ocado managed to clock a healthy top line but EBITDA was below our expectations in H1 19. Going forward, the performance of both core segments (retail and solutions) is expected to gain strength. Ocado Zoom continues to be a promising proposition but is still in its early stages. We will tweak our estimates slightly but maintain the stock recommendation.
17 Jul 19
No surprises in Q1
The Q1 performance is encouraging considering management’s success in limiting the impact on sales due to the fire at the Andover facility. Some makeshift arrangements to mitigate the supply disruptions is also likely in our opinion. The initial assessment of the fire incident does not highlight any grave concerns regarding the viability of Ocado’s business model. Management also considers the initial results from the trial of Ocado Zoom (one hour delivery service) as encouraging. No change to our stock recommendation.
19 Mar 19
New supply partner in the UK
Ocado and M&S have announced the formation of a JV today. According to the deal, M&S will take a 50% stake in Ocado’s retail business for a total consideration of up to £750m, including a deferred payment of up to £187.5m, plus interest. The JV will start trading as Ocado.com from September 2020 at the latest (this is when Ocado’s existing food supply contract with Waitrose will expire) and will stock M&S’s own-brand products. The transaction is expected to be completed in Q3 FY19. M&S plans to finance this deal by conducting a Rights Issue (raising up to £600m) and by cutting its dividend pay-out to shareholders by 40%.
27 Feb 19
Facing hurdles in the near term
While we do not see any red flags in the FY18 results, the announcement of a one-hour delivery service is encouraging. If successful, ‘Ocado Zoom’ should aid Ocado in improving market share and shareholder wealth in the mid/long-term. Although the fire incident at the Andover facility will be a pain-point / earnings adverse in the near term, we see the 17% plus stock price slump over the past 48 hours as an over-reaction. No change in the stock recommendation.
07 Feb 19
Nothing abnormal in the Q4 results
There was no surprise in the Q4 trading update. We believe the retail business will continue to clock double-digit growth in the coming quarters. The Solutions business also seems to be on the right track, with the first CFC likely to go live in 2020. Assuming management will be able to execute these client contracts on time, we believe the stock is currently trading at very attractive levels. No change to our stock recommendation.
14 Dec 18
Ocado banks on the Ohio
Kroger and Ocado have announced that Monroe, Ohio, subject to the provision of local grants, will be the location for the first US customer fulfilment centre. The announcement is clearly good news and an important next step in what could be a substantial business state-side in the long-term; the announcement of the Kroger tie-up effectively propelled Ocado’s equity into the FTSE-100, which in truth is a great achievement. Whilst so, as ever, we have very limited visibility as to the net capital cost of the US adventure, the first CFC will cost Kroger $55m (is that $1.1bn for twenty planned outlets?), and even less about likely revenues and EBITDA. As for EBIT and PAT, well these are variables that the somewhat charmed Ocado does not have to worry about, unlike most companies, as the market gives it enormous grace to develop, capitalise, expend and deliver little financial return on capital. However, grace and fortune are undoubtedly virtues in life and if one cannot be financially good, then just be lucky. Ocado’s US activities rest alongside a suboptimal UK business in terms of capital returns and much ambition and potential seemingly in Europe too albeit again, aside from capital expenditure, we have little visibility on financial delivery. We intend to re-commence coverage on Ocado stock in due course hence, NO RECOMMENDATION, COVERAGE PENDING.
20 Nov 18
Stock price slumps 10%; attractive entry point for mid-term investment
Ocado slipped c.10% yesterday. While there was no company specific news, this sell-off can be attributed to many factors: 1. Triggered by a broader sell-off in tech stocks after disappointing outlooks from chipmaker AMS (the Austrian chipmaker) and Logitech International (Swiss computer parts manufacturer). Investors might also have become nervous as tech-giant Amazon will be announcing its earnings results this week. 2. Weak overall sentiment about European (and British) stocks, led by companies posting weaker than expected results, discomfort in Italy and Brexit-related jitters. 3. Disappointing 2018 guidance by heavy machinery maker Caterpillar (rising costs due to tariffs), which is considered as an indicator of Chinese demand, might have also added to the concerns about the prospects of the global economy. We believe the fundamentals of the company remain intact as management is on track to develop/establish the CFCs (automated warehouses) for its clients. These CFCs are part of the Solutions business (involves monetisation of Ocado’s proprietary solution ‘OSP’), which is estimated to be the key earnings driver for the stock in the mid/long-term. Moreover, the retail business in the UK is also estimated to remain healthy. From the valuation perspective, we believe Ocado is already trading in a very attractive territory. Any further price fall related to macro uncertainties is likely to be the icing on the cake for mid-term investment (i.e. a holding period of at least two years).
24 Oct 18
Softer H1 results but business model is still promising
The dip in H1 profits is surely a disappointment but the business fundamentals remain intact. We believe the current stock price already factors in at least two new partnerships (estimating three CFCs each). Any new announcement is unlikely to be needle-moving unless management succeeds in on-boarding another heavyweight akin to Kroger. No change in stock recommendation.
11 Jul 18
On a joy-ride
It seems Ocado is on a partnership spree. The UK-based e-com grocer come technology firm has announced a fourth international partnership within a span of six months. The latest addition to its kitty is Kroger, the second largest food retailer in the US. Under the agreement, Kroger will have access to Ocado’s Smart Platform ‘OSP’ (a proprietary automated warehouse facility) for grocery and other food distribution related activities. The fee structure will be broadly similar to previous deals, except for a reduction in the initial capital requirements for Ocado compensated by lower ongoing fees. The US retailer will subscribe to 33,146,200 new Ocado ordinary shares (5% of the existing issued share capital) for £183m. This will bring the company’s total investment in Ocado to more than 6%.
18 May 18
Value contingent on the solutions business
Recommendation and upside We are initiating coverage of Ocado Plc. (market cap. of £3.3bn and a float of c.67%) with an ‘Add’ recommendation and a target price of 570p (c.13% upside). Our upside is driven by the robust growth in both business segments. The solutions business is likely to take the driver’s seat as Ocado monetises the proprietary solution OSP by offering it to other retailers. Management’s recent success in forging two partnerships in France (traditionally inclined towards a network of ‘Drives’ vs home delivery in the UK) and North America is strong evidence of Ocado’s top-notch technology-driven proposition. We estimate the company will continue to forge similar partnerships in future, largely confined to the USA and Europe. The retail segment is also likely to sustain the ongoing momentum, due to: 1) expansion of the online grocery format in the UK – the fastest growing format (+53.8% by 2022 vs 15.4% for the overall UK grocery market), – underpinned by the ongoing structural shift in consumers’ buying preferences, 2) Ocado’s ability to gain market share, on the back of a best-in-class business model (among one of the few profitable online grocers across the globe), becoming more competitive by benchmarking the prices against Tesco and economies of scale – gradual increase in SKU count, increased delivery slots with higher geographical density and better routing. In 2014, investors lost faith in Ocado’s growth story after management failed to add new clients in its solutions business (although the retail business was growing satisfactorily). However, the stock price has more than doubled since November 2017 after the company announced two back-to-back deals in this segment (Casino and Sobeys in France and Canada, respectively). The company is likely to witness strong cash generation after the high investment phase (capex at c.10% of group revenue vs 2.4% for traditional UK grocers) in technology and new CFCs normalise in the out-years. Business and Trends Ocado is one of the most promising pure-play online grocers in the world. It relies on proprietary / best-in-class technology for online retailing, logistics and distribution of products (e.g. use of bots in fulfilment centres, routing software for efficient product delivery, artificial intelligence to engage customers). The UK-based retailer operates through two business segments, retail and solutions. The retail segment (14.6% CAGR during FY12-16) generates c.92% of total revenue, which includes sale of goods through ‘Ocado.com’ to an active customer base of over 580,000 (covers 70% of the UK population and 50% of total area). It sources the majority of the products from Waitrose and, hence, is perceived as offering good quality products but at slightly expensive prices. Although Ocado commands only a 1.3% share of the UK grocery market (worth £185bn), it ranks third (after Tesco and Sainsbury) in the online food segment with a market share of c.16%. The firm’s non-food business is still in the nascent stage and constitutes c.7% of total retail sales. It started in 2013 with launch of pet goods website (Fetch.co.uk), followed by kitchen goods website (Sizzle.co.uk) in the subsequent year. In 2016, the company launched a premium beauty destination site and flagship physical store, Fabled, in partnership with Marie Claire. The solutions business involves monetisation of Ocado’s proprietary solution ‘OSP’ (owns over 200 patents / patent applications) by offering it to other retailers. The solution presents a blend of automated warehousing and distribution capability, and physical fulfilment centres to assist the retailers to launch / expand their e-commerce business. The fulfilment assets are modular (can be built to almost any size) and scalable (can be built in multiple phases) and, in turn, help the business partners to operate in a capital-light manner. OSP tasted its first commercial success in 2013 by entering into a 25-year agreement with UK’s fourth largest grocer Morrisons – the task involved the launch and operation of the online business (Morrisons.com). The two companies formed a JV, with equal sharing capacity rights of Ocado’s Dordon customer fulfilment centre (CFC). Morrisons agreed to pay a combination of upfront cost, annual service cost, R&D expenditure and a share of the positive EBIT from the new business. However, the deal was renegotiated in 2016: 1) Ocado agreed to expand Morrisons’ delivery coverage by granting it additional capacity at Erith CFC (scheduled to open in 2018), 2) Ocado became free to forge partnerships with other UK retailers, excluding Tesco, Sainsbury’s, Asda, Aldi and Lidl, and 3) in return, Morrisons terminated the profit-sharing clause with Ocado for the next 15 years. Need to know As of FY16, Ocado’s retail business enjoyed slightly better profitability vs solutions (6.5% vs 5.5%) and accounts for c.90% of the group’s EBITDA. However, contribution of the solutions business should rise in the coming years as retailers across globe are shifting their focus to strengthen the e-commerce platform (triggered by Amazon’s big leap into grocery business with the acquisition of Whole Foods last year). Despite a mid single-digit EBITDA margin and negligible tax payments (benefiting from the accumulated tax losses), Ocado has failed to generate positive FCF (£-21m in FY16). This is largely due to the high capital expenditure (explained above) as the entity has invested heavily in the automated warehousing capability (D&A expense at c.5% of the group revenue is also almost double that of UK grocers). No wonder, the group has a depressed ROE (c.5%; turned positive in 2014) and ROCE (c.150bp below the 7.2% WACC). Upcoming triggers We expect the next major trigger for the company to be the onboarding of new clients in the solutions business. Moreover, a sustained top-line momentum in the retail segment (>10% yoy) and improving profit margins are also likely to nudge investors’ sentiment. Moreover, a takeover attempt by big retailers (to improve their e-com proposition in an increasingly competitive landscape) cannot be ruled out considering the c.67% free float for the stock. The grocer is a strategic fit especially for Amazon – the US retailer has more to lose if Ocado’s solutions business decides to bulk-up opponents such as Kroger and Wal-Mart.
23 Feb 18
Who's afraid of Amazon?
Recent media coverage has highlighted the possibility of Amazon’s online grocery offer (Amazon Fresh) being launched in the UK this year with a feared negative impact on Ocado, the UK’s leading online grocery retailer. We believe these fears are overdone and are reminiscent of Wal-Mart’s entry into the UK with its 1999 acquisition of ASDA, which did not change the UK food retail sector in a material way (unlike the recession a decade later coupled with the expansion of German hard discounters). Going forward, the endorsement of the Ocado Smart Platform by new partners should provide reassurance about the viability of Ocado’s online model.
04 Aug 15