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Ocado - Strong sales growth in final quarter

George Salmon | 8 December 2016 | A A A
Ocado - Strong sales growth in final quarter

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Ocado Group plc Ordinary 2p

Sell: 933.60 | Buy: 934.80 | Change -4.00 (-0.43%)
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Strong sales growth in final quarter

Shares in Ocado fell 3.5% following the release of a brief fourth quarter trading update.

In the 16 weeks to 27 November 2016 gross retail sales rose 13.1% to £398m. Average orders per week grew 17.6% to 241,000, assisted by increased take up of the Ocado 'Smart Pass'. However, customers shopping more frequently, combined with industry-wide price deflation, means the group's average order size continues to decline, falling 2.9% to £105.61 in the period.

CEO Tim Steiner is pleased with the group's performance in the year, and is optimistic that the new equipment and software in the recently opened Andover customer fulfilment centre will support the ongoing growth of the business.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

Our view:

In theory, Ocado ought to make good margins. Shorn of the costs of a store estate, its highly efficient customer fulfilment centres (CFCs) churn out tens of thousands of orders each and every day, largely without human intervention.

The reality is that fifteen years or so since it came into being, Ocado doesn't make much money, even whilst trouncing the opposition in terms of service.

Ocado's prices are typically higher than its competitors', so the last thing that it wanted to see was an online retail giant parking tanks on their lawn. Unfortunately, with Amazon launching their Fresh grocery service, this is exactly what Ocado has got. This is clearly a worry, and the likely knock-on impact is for margins to remain low for some time.

Nonetheless, as sales rise the group should be able to easily improve efficiencies through increased scale and via the maturity of their CFCs at Andover and Erith. The issue is Ocado trades on over 100 times prospective earnings and is struggling to make operating margins of more than 2%.

In reality nobody wants to hold Ocado for years watching it make paltry margins. The high valuation is based on the potential for other companies to sign deals to use its technology. Such agreements will ideally include upfront licence fees and then a stream of royalties. If deals come in, these royalties could soon make up for the limited profitability of the core business.

However, Mr Steiner has been saying that Ocado is 'in talks' for quite a while now but he is yet to get anyone to sign on the dotted line. He'll be hoping that the new technology at Andover proves its worth and helps to bring the deals in.

Ultimately, it's 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.

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