Ocado’s share price is up over a huge 50% this year as shareholders continue to buy into the online grocer’s expanding retail and technology operations.
On the retail front, the 12 weeks to 14 July saw Ocado [OCDO] hit an 11.9% rise in sales, at the expense of the wider sector which saw a 0.5% dip. The only other supermarket on the up was the Co-Op, although at 0.2% growth this was relatively small beans.
On the tech side of things, Ocado has gone into a string of partnerships to provide end-to-end online grocery solutions for other grocers, including Coles in Australia and Kroger in the US. Yet a fire at its high-tech Andover warehouse has seen the stock slide 12% since April. Also dragging on the share price is the sheer cost of its technological ambitions.
What's driving growth?
Decline in the big four supermarkets
Tesco, Asda, Sainsbury’s and Morrisons - the big 4 UK supermarkets - saw a collective 2.1% decline in sales in the three months to 14 July. Although it was a different story last year as Fraser McKevitt, head of retail and consumer insight at Kantar explains:
“The main factor behind the sales drop-off is shoppers heading out to stores less often. Last year people shopped more frequently and closer to home as they topped up the cupboards while enjoying the sunshine and the men’s football World Cup.”
While the big four still account for two thirds of all supermarket sales, Ocado was the only grocer to see double digit growth. Not only were sales up almost 12%, but Ocado’s shopper base grew by 6% as more shoppers opted for online shopping.
Increase in Ocado's shopper base in the three months to 14 July
International tech deals
Best known for online groceries, Ocado is now in the business of building state of the art customer fulfilment centres for other retailers. In March, Ocado's share price jumped after striking a deal with Australian supermarket Coles - at that point the fifth joint venture that Ocado had agreed in less than two years.
Ocado has announced a $55 million deal with US grocer Kroger to build a customer fulfilment centre in Georgia, equipped with automated robotic technology. The plan is to build more across the US, with Ocado and Kroger breaking new ground on a second US warehouse in Groveland, Florida on Friday.
Ocado has also partnered with Sobey’s to develop an online grocery business for the Candadian retailer which has over 1500 stores. Closer to home, Ocado has entered into similar deals with Swedish supermarket chain ICA and French Groupe Casino.
The tenacity to expand its technological business has led one analyst to nickname the company the ‘Microsoft of retail’. In a succinct statement accompanying half-year results, Ocado appeared to acknowledge this shift in direction:
“Ocado Group has shifted from our heritage as an iconic and much-loved domestic pure-play online grocer to our future as a technology-driven global software and robotics platform business…”
“Ocado Group has shifted from our heritage as an iconic and much-loved domestic pure-play online grocer to our future as a technology-driven global software and robotics platform business…” - Tim Steiner, Chief Executive Officer of Ocado
Partnership with M&S
For many, Ocado's service is synonymous with Waitrose. After all, the company spent 19 years delivering the upmarket supermarket's goods to online shoppers. Yet following an acrimonious split from Waitrose last year, Ocado has now partnered with M&S to provide its groceries from September 2020.
As part of the £750 million tie-up, M&S has purchased a 50% share in Ocado's UK retail business. This will also give M&S its first retail home delivery service by September 2020.
One concern would be that M&S doesn't offer the same amount of choice as Waitrose, particularly on branded products. A recent poll of 250 Ocado customers showed that a “meaningful proportion” were loyal to Waitrose, and not to M&S Worryingly, a fifth of those surveyed would not shop at Ocado if Waitrose products were unavailable. According to David Mcarthy, a retail analyst at HSBC, if this proves representative of the customer base then the “profit implications could be severe due to operational gearing and low profits.”
Ocado’s recent half-year results saw the company’s losses increase to £142.8 million as the company wrote-off the cost of the Andover warehouse fire. Disruption from the fire is expected to result in a £15 million hit on group EBITDA this year. Barclays analysts think this will actually translate to a full-year EBITDA of about £20 million, a steep drop from the forecasted £45 million.
Ocado expects revenue from its retail arm to grow 10% to 15% over the 2019 financial year. Although the company's solutions division, which is responsible for its warehouses, is a different story, with an additional £15 to £20 million thought to be needed to cover costs.
|PE ratio (TTM)||16.36|
|Return on equity (TTM)||-35.28%|
Ocado share price vitals, Yahoo finance, 30 July 2019
Time to buy?
With costs mounting investors are concerned about Ocado’s ability to turn a profit. Over the past 12 months, profit margins are at -10.32%, while operating margins have declined to -3.95%. Return on equity is also in negative territory, coming in at -35.28%, while operating cash flow still remains insufficient to cover total debt.
While a £562.5m upfront cash payment from M&S as part of their newly minted partnership will certainly allay cash flow fears for the time being, the switch from Waitrose must be seamless. Ocado will also need to keep winning international contracts to keep growing and justify the soaring share price. Given the underlying financials, failure on either count could cause real problems for Ocado.
Yet analysts are backing Ocado, which has an average 1700p price target; this would represent a 40% upside if hit. While the consensus rating is "Strong Buy", any miss on its retail or technological operations could see that rating being substituted for something less desirable. Investors will be scrutinising Q3 results, due on 17 September, to see if Ocado stands a chance of hitting its full-year targets, and truly becoming the ‘Microsoft of retail’.
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