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.
Retailing groceries over the web is a very different proposition to retailing general merchandise, with different supply chains, logistics, several temperature zones required, picking and packing many more items etc. So far, Amazon Fresh only operates in a few cities in the US and in the UK, when it does start making an impact, it might ultimately contribute to a bigger online grocery market (currently c 5% of total UK grocery sales, according to IGD).
Ocado has evolved significantly since its IPO in 2010. Ocado.com is delivering sales growth of 15-20% pa, improving efficiency (all KPIs have been improving over the past five years) and increasing profitability. Waitrose’s supply agreement with Ocado.com is ongoing (contract should be reconfirmed in September 2015) and WM Morrison (4th largest UK retailer) has opted to operate its online grocery business on the back of the company’s technology and platform (Ocado Smart Platform). However, the lack of new partners is creating market uncertainty around the company’s business model, which we believe is understandable given the still evolving world of online retailing. The announcement of new partners in the coming months, as pledged by the company, could therefore act as an important catalyst.
Ocado is posting considerable - and increasing - profits at the operating level, but choosing to re-invest these into further evolving both its platform and online grocery business, thereby lowering reported profits but potentially increasing the value of the company. With Ocado valued at c. 2x consensus 2016e EV/Sales, in line with the online retail sector, the Ocado Smart Platform looks like a free option.