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Ocado - Q3 retail revenue suffers after fire

Sophie Lund Yates, Equity Analyst | 14 September 2021 | A A A
Ocado - Q3 retail revenue suffers after fire

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Ocado Group plc Ordinary 2p

Sell: 1,682.50 | Buy: 1,683.50 | Change -61.00 (-3.50%)
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Ocado Retail - which is 50% owned by Marks & Spencer - saw third quarter revenue fall 10.6% to £517.5m. Revenue fell 1.8% in the first 6 weeks. Following the fire at the Erith fulfilment centre in July, lost capacity and sales meant revenue fell 19% for the rest of the period.

Ocado processed 338,000 orders a week, up 1.4% on last year. New capacity means the group can now process up to 600,000 orders a week, and announced plans to increase this to 700,000 in 2022-2023.

The total cost of the fire, not covered by insurance, is expected to be around £10m. Rising labour costs, particularly in LGV and delivery drivers, will cost up to £5m at the full year. The group said Ocado Retail "expects to deliver strong revenue growth in FY22".

The shares fell 6.7% following the announcement.

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Our View

Ocado Retail - 50% owned by M&S - disappointed in the third quarter.

Sales fell over 10%, thanks to lost sales followingrom the fire at the Erith Fulfilment Centre, and a slowdown compared to the exceptional demand from last year's lockdowns. Damage from the fire is now expected to cost Ocado about £10m, while labour shortages and, higher staff costs, including incentives, will add up to £5m in costs, hurting profit.

Predicting trading patterns from here is tough, too. Exactly how much of the increased demand from the last 18 months is permanent is unknown. Driver issues could be more of an issue for Ocado than for other retailers. It prides itself on being a more premium grocer, so if it can't get the right stock, this will sting sales.

But the business case for Ocado PLC hinges on a very different story to the delivery vans you'll see on roads nationwide.

Ocado Solutions charges third party 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.

The pandemic has turbo charged the shift to online shopping, increasing demand for the kind of technology Ocado specialises in. That should make it easier for Ocado to unearth potential partners and strike more deals. But we'd argue the number of new deals being struck is still modest, given the helpful market conditions.

Plus, expansion comes at a cost, with Ocado stumping up hundreds of millions to fund Customer Fulfilment Centres (CFCs) - a far cry from the capital-light, tech business investors had once expected. The group's already massively upped its planned capital expenditure, and yet more investment has been announced at the half year. The group's plan is to strike while the iron's hot and develop as many CFCs in international markets as possible.

But the rate of profitability is a disappointment. And the centres are long term investments, so it takes years to know if they will pay off.

A net cash pile means we don't have any near-term funding concerns. But it's important the expected wave of new deals comes to fruition. If things don't go to plan, we can't rule out Ocado asking investors to open their wallets again.

We should be clear we think Ocado has a pretty amazing product. It's the only global provider of an end-to-end, online grocery platform. That's an enviable position in today's climate. As the group builds scale and partnerships mature, profits and free cash should flow. But if new Solutions deals don't come fast enough, that plan gets thrown.

Thin profits make Ocado hard to value, but on a share price to sales basis, the market's excited. This is a mark of confidence, but could limit upside potential - and means there's a lot resting on everything going smoothly from here.

Ocado key facts

  • Price/sales ratio : 4.7
  • Ten year average Price/sales ratio: 2.6
  • 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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Half year results (6 July 2021)

Ocado's half year revenue rose 21.4% to £1.3bn, reflecting growth in all divisions. Underlying cash profits (EBITDA), which excludes costs relating to the Andover fire, more than tripled to £61.0m. This was entirely driven by Retail and the UK Solutions & Logistics businesses.

A new deal was announced with Auchan Retail to develop Alcampo's online business in Spain.

Ocado doesn't "expect a material change to consensus Group EBITDA forecast" for the full year, thanks to a stronger performance from Retail.

Retail - the 50% joint venture with Marks & Spencer, revenue rose 19.8% to £1.2bn, reflecting a similar rise in the average number of weekly orders. These now stand at 356,000. This offset average basket size, which increased by just £1 to £138. The number of active customers has risen to 777,000, from 640,000 at the end of the last financial year. Despite higher costs, especially in Distribution, cash profits of £104.1m were more than double this time last year.

Increased capacity at the Erith Customer Fulfilment Centre, and the new mini CFC in Bristol, helped UK Solutions & Logistics revenue rise 13.1% to £357.3m. That includes a 30.7% rise in fee revenue to £73.2m, and a 9.3% improvement to cost recharges. Cash profits were helped by the higher fee collections, and rose 27.0% to £30.1m. Two new CFCs are due to open in the second half, which will increase capacity by 145,000 orders a week.

The International Solutions business recorded revenue of £26.6m, compared to £1.6m last year. The increase largely reflects the contribution from the first two CFCs for Kroger going live in the US. Fees invoiced fell almost 32% to £50.2m. Increased investment offset the higher revenue, so cash losses widened from £39.7m, to £56.6m.

Share-based senior management incentive charges, charges relating to deferred consideration for the Kindred Systems and Haddington Dynamics acquisitions, and losses in the Jones Food Company meant Other cash profit losses were £16.6m.

There's been weaker-than-expected revenues from recently acquired Kindred systems. The group's also expecting increased investment in technology. Together with a non-cash charge, relating to the timing of Ocado's payment for Kindred Systems and Haddington Dynamics, means full year EBITDA expectations from International Solutions, UK Solutions & Logistics and Other segments will be £30m lower.

There was a free cash outflow of £137.7m in the half. Net cash was £188.5m at the end of May 2021, compared to £196.2m last year.

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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.