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Ocado - upgrades full year guidance

Sophie Lund-Yates, Equity Analyst | 2 November 2020 | A A A
Ocado - upgrades full year guidance

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Ocado Group plc Ordinary 2p

Sell: 931.80 | Buy: 932.80 | Change 7.40 (0.80%)
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Ocado's retail joint venture with Marks & Spencer, Ocado Retail, has seen strong trading in the fourth quarter. Ocado said demand is high as customers are shifting to online grocery shopping in "record numbers".

Sales are currently in line with the trends seen in the third quarter. As a result Ocado group as a whole expects full year cash profits (EBITDA) of £60m, compared to previous guidance of £40m.

Ocado also announced the acquisition of Kindred Systems and Haddington Dynamics, for a combined total of around $287m. These business are expected to enhance the group's robotic systems in its automated Customer Fulfilment Centres (CFCs).

The shares rose 6.6% following the announcement.

View the latest Ocado share price and how to deal

Our View

Coronavirus has accelerated the shift to online shopping. This benefits Ocado not least because increased retail sales means it expects to leave loss making territory this year, and profit guidance has even been pushed further into positive territory.

A second national lockdown in the midst of the festive trading season is likely to accelerate this side of the business further.

And as we saw in the third quarter, increased trading means margins are looking brighter. As more orders rattle through Ocado's expensive robotic warehouses, its infrastructure enjoys operational leverage as each extra sale doesn't cost a lot and can drop through to profit. But investors shouldn't be blindsided by this - profits are still going to be pretty thin on the ground.

And in reality the headline act is still the Solutions business.

After selling half the retail business to M&S, this department holds the key to future growth. It charges retailers to use Ocado's robotic systems. Hundreds of thousands of orders are processed each week, with the help of automated 'bots' scurrying around the trademarked grid systems.

Coronavirus is likely to have created a permanent increase in demand for online groceries. In theory that means Ocado will be able to unearth a higher number of potential partners and strike more deals as grocers look to increase their online capacity. But it's not a home-run just yet.

Ocado is having to stump up hundreds of millions to fund a lot of the Customer Fulfilment Centres itself - a far cry from the capital-light tech business investors had once expected.

The Solutions division continues to burn through cash at a heady rate. That isn't likely to change for some time. In fact it's pretty hard to know when this will change, because the centres are long term investments. So while landing the deals is key, it'll be years before we know if they'll pay off.

And recently added to the shopping list is two robotics companies. These should boost Ocado's already impressive automated systems, and we think they're a good purchase. But a bit like the CFCs themselves, we don't know yet if these expensive additions will be worth the price tag.

In terms of liquidity we don't have any immediate concerns, with access to over £2bn in gross cash sitting on the balance sheet at the last count. We don't doubt that Ocado has a great product, and it's well placed to capture a shift to online shopping. But it's crucial the expected wave of new deals comes to fruition. If things don't go to plan it's going to be a while before Ocado can ask investors to open their wallets again.

It's important to take Ocado's valuation into account too. Its thin profits makes it harder to value than a more traditional company. Looking on a purely sales basis, the shares change hands for almost three times more than the ten year average. That means if the Solutions business falters, so will the share price.

Ocado key facts

  • Price/Sales ratio: 6.4
  • 10 year average Price/Sales ratio: 2.3
  • Prospective dividend yield (next 12 months): 0.0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Acquisition details

Advanced piece picking and robotics company, Kindred Systems will be bought for $262m, subject to closing adjustments. The deal will be paid for using Ocado's existing cash reserves, although around $4m will be retained by Ocado as deferred payment and paid out to certain employee shareholders of Kindred.

Kindred is expected to generate revenues in excess of $35m in 2021. It generated revenues of $0.3m and a net loss of $15.8m in 2018, and revenues of $1.7m, and a net loss of $16.2m in 2019. As of 31 December 2019, the group had net assets of $25.0.

Ocado said: "Kindred Systems' existing customers are focused on robotic picking within the general merchandise and logistics sectors". The deal's expected to close in 2020, but is subject to US regulatory approval and employee retention.

Haddington Dynamics will be bought for around $25m, subject to closing adjustments. Ocado will pay about $7m in in cash and issue 0.6m new shares. This business is a robotic-arm designer and manufacturer, based in Las Vegas. It currently counts NASA and DuPont as clients.

The acquisition is also expected to complete during the 2020 calendar year, and is subject to regulatory and commercial approval in the US.

Overall these deals will have no financial impact for Ocado this year. Full year revenue for 2021 is expected to increase by around £30m, and there will be a small negative impact on cash profits (EBITDA).

Third quarter trading details

Retail revenue rose 52% to £587.3m in the third quarter (which ended on 30 August 2020). The group also said the customer reaction to the switch over to Marks & Spencer products on 1 September has been positive.

The improved retail revenue reflects increased demand for online groceries and the positive effect of last year's weaker Q3 sales. Order sizes are continuing to normalise following the peaks seen in lockdowns, but are still higher than pre-crisis levels.

The average number of orders per week rose 9.6% to 345,000 and the average order size was £141.

The Marks & Spencer launch increased the average number of items per basket by five, and the weighting of M&S products compared to Ocado items is higher than the preceding retail partner, Waitrose.

Ocado is on track to increase capacity by 40% through to 2021.

Find out more about Ocado shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown.. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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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