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Ocado - M&S buy 50% of UK retail business

Nicholas Hyett | 27 February 2019 | A A A
Ocado - M&S buy 50% of UK retail business

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Ocado Group plc Ordinary 2p

Sell: 939.40 | Buy: 940.40 | Change 11.20 (1.21%)
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Ocado has agreed to sell 50% of its UK grocery business to Marks & Spencer for a total consideration of £750m. The proceeds from this sale will fully fund development of customer fulfilment centres with Ocado's current Solutions partners.

The shares rose 1.5% in early trading.

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Our view

The sale of 50% of Ocado's UK retail business might leave you scratching your head...'exactly what does Ocado do if it's not scurrying around delivering upmarket groceries?' But Ocado's £6.8bn valuation is based on much more than a niche online supermarket.

Its cutting edge systems are capable of fulfilling tens of thousands of orders every day, largely without human intervention. And those whirring technology systems are a product themselves, with other retailers paying license fees to make use of them.

Agreements with retailers in Canada, France, and a major deal in the US are a good start in Ocado's transformation from small British online retailer to international technology provider. But these initial projects will be being watched closely by potential future partners.

Ocado's on the hook to fund some of the Customer Fulfilment Centres involved in those deals, and that had led to some speculation it may need to raise money. However, the M&S deal provides more than enough cash to meet current commitments.

A 50/50 joint venture with M&S also slims Ocado's direct exposure to food retail. Tesco manages an operating margin of around 3% on its £60bn-ish of sales. Ocado might not be able to match it on the top-line, but its solutions business should eventually enjoy a margin that's many multiples of Tesco's. Since its technology would underpin some of the world's leadings grocers, revenues could be more reliable too.

But all that relies on Ocado's ability to sign more partnerships, and a recent fire at one of its biggest warehouses won't look good. The full extent of the damage isn't known yet, but Ocado could've done without burning a hole in its own shop window.

Ocado has impressed with its progress up until this point, and exceeded most expectations. Because it's growing so quickly, dividends are unlikely for a while. However, we think the group's right to allocate every penny to making the most of the opportunities in front of it.

Overall, we think Ocado is an impressive business, with a genuinely revolutionary product. If it can deliver, then the rewards could be substantial.

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Full Year Results - 5 February 2019

Full year group revenue increased 12.3% to £1.6bn. However, increased investment, and depreciation charges following the new Customer Fulfilment Centre (CFC) at Erith, meant pre-tax losses grew to £44.4m.

Retail revenues rose 12% to £1.5bn, as the average number of orders per week increased 12.1% to 296,000. The average value of each basket was slightly lower at £106.85 (2017: £107.28), as higher prices were offset by a decrease in basket size.

EBITDA (earnings before interest, tax, depreciation and amortisation) from the division grew at the slower rate of 4.2% to £82.5m. As extra marketing, delivery and head office expenses, saw costs rise

The Solutions division earned revenues of cash fees from partners of £200.1m (2017: £146.1m). That includes deals with Morrisons, and more recent international contracts with Bon Preu, Casino, Sobeys, ICA and Kroger.

However, EBITDA declined to a loss of £17.9m. But that's been driven by accounting changes, which means the timing of when Ocado can recognise revenue has been changed.

Total capital expenditure was £213.8m, a 33.4% increase on last year. Increased spending on improving operations at newer CFCs were the main drivers for this.

Next year, Ocado expects total capital expenditure to be £350m, as it will need to increase spending to deliver new CFCs and support new solutions partners.

Investment in the new CFCs means the solutions division will continue to be loss making in the coming year. No new centres are due to open next financial year, but 23 are in the pipeline for the longer-term.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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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