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Ocado - Sales growth strong but margin pressures creeping in

George Salmon | 13 September 2016 | A A A
Ocado - Sales growth strong but margin pressures creeping in

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Ocado Group plc Ordinary 2p

Sell: 2,687.00 | Buy: 2,690.00 | Change 15.00 (0.56%)
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Ocado has this morning released a trading statement for the 12 weeks to 7 August 2016.

Although sales and order numbers continue to grow, Ocado CEO Tim Steiner acknowledged that the market remains very competitive, and the group is seeing sustained margin pressure which is likely to continue for at least the short term. The shares fell by over 7% this morning.

Gross retail sales have risen by 13.6% to £286.4m, while gross group sales, which include the benefit of the Morrison agreement, rose by 15.4% to £314m.

The group's average orders per week continues to rise, having moved from 190,000 to 226,000 year-on-year, while the average order size fell by 3.4% to £107.94.

Despite his comments on margin pressure, Mr Steiner remains confident that the group can grow ahead of the online grocery market, and substantially ahead of the market overall.

Our view:

In theory, shorn of the costs of a store estate, highly efficient customer fulfilment centres (CFCs) churning out tens of thousands of orders each and every day, largely without human intervention, ought to make good margins. The reality is that fifteen years or so since it came into being, Ocado does not make much money, even whilst trouncing the opposition in terms of service.

The problem seems to be that Ocado is not suited to being anything other than a large-scale operator, and is hamstrung by its lack of scale meaning its prices are high in a competitive market.

Amid this competition, and with food price deflation sending prices down, the last thing that Ocado wanted to see was an online retail behemoth parking tanks on their lawn. Unfortunately, with Amazon launching their Fresh grocery service, this is exactly what Ocado have got. This is clearly a worry, and the likely knock-on impact is for margins to remain low for some time.

However, as sales continue to rise, Ocado should be able to easily improve efficiencies through increasing its scale and via the maturity of their CFCs at Andover and Erith. But that will be a long haul. No-one wants to hold Ocado for years, watching it making paltry margins. The market wants to see deals done for others to use Ocado's systems. Ideally such deals will include upfront licence fees and then a stream of royalties. But so far, Ocado has not been able to get anyone to sign on the dotted line.

If Ocado do end up signing multiple deals in multiple territories in the next few years, as the CEO expects, then the company could well have real potential in the years ahead. The problem is that Mr Steiner has been saying that Ocado is 'in talks' for quite a while now. At present, Ocado is trading on over 100 times prospective earnings and struggling to make an operating margin of more than 2%.

If the deals come in, then the royalties could soon make up for the limited profitability of the core business. But it is a chicken and egg situation. Who will sign up, to pay multiple millions to emulate a business that is not yet rudely profitable?

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.