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Ocado - Retail guidance lowered

Ocado has said the broader retail environment has deteriorated as the cost-of-living crisis, a return to more normal...

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Ocado has said the broader retail environment has deteriorated as the cost-of-living crisis, a return to more normal consumer behaviours and food price inflation have impacted trading. As a result, Ocado Retail (the joint venture with M&S) has seen customers' average basket value fall 9% year-on-year and sales are around 8% down so far in the quarter.

So far in the second quarter, Ocado Retail has continued to bring on board new customers, up 12% year to date, and completed 400,00 weekly orders for the first time over week beginning 9 May.

Given the challenges, Ocado Retail expects sales growth for the year to be in the low single digits as opposed to around 10% as previously guided. That implies a cash profit (EBITDA) margin also in the low single digits.

The shares fell 4.6% following the announcement.

View the latest Ocado share price and how to deal

Our view

Ocado Retail - 50% owned by M&S - is the business behind the delivery vans you'll see on roads nationwide. New customers are coming on board but a range of difficulties for the broader market and consumers mean order sizes are coming down, growth's slowing, and the outlook's getting a little bleak - at least in the short term.

More concerning are the ever-increasing cost pressures. They're more prominent than expected and starting to have a material impact on performance. All-in, revenue growth for Retail has just taken another hit, down to low single digits.

But growth for Ocado hinges on a very different story.

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. Leveraging that backdrop to attract new partners has been a struggle, though.

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 upped its planned capital expenditure yet again, and increased investment has become a staple line in company results.

That's all well and good so long as new deals are forthcoming. The group's foray into France means there's a new addressable market on the docket, but until there are actual customers it's difficult to get excited. The new partnership in Poland is also a step in the right direction, but this needs to act as a catalyst for more. Investing heavily is justified when scalability is supposedly round the corner, but so far this isn't the case.

The rate of profitability of existing Customer Fulfilment Centres (CFCs) is also a disappointment. And the centres are long term investments, so it takes years to know if they will pay off.

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, which is a possibility if potential partners rein in spending given fears a global recession could be round the corner, 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. 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 previous excitement looks to be long gone. The group now trades a decent way below its longer-term valuation. We share the cautious sentiment given the uncertain market and progress in Solutions is needed before we can be more positive.

Ocado key facts

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.

Full Year Results (8 February 2022)

Ocado Retail (the joint venture with Marks & Spencer) saw sales decline 5.7% in the quarter, to £564.7m. This reflected strong sales in 2021, boosted by the pandemic. Sales for the wider UK grocery market were 4% lower. Average orders per week grew 11.6% to 367,500, but that was more than offset by a 15% drop in the average basket size (£124) as customer behaviours shifted back toward pre-covid levels.

The Bicester customer fulfilment centre (CFC) is set to open this year, adding capacity for 30,000 orders per week in the second half. Sites in Purfleet and Andover are up to around half their maximum capacities, now operating at a combined 65,000 orders per week. A new Zoom facility (same day delivery) is set to open in Canning Town this Spring, with further sites in the pipeline over the next 12 months.

The group saw a ''significant'' increase in a range of costs from raw materials to energy, passing these onto customers in the form of higher prices where possible. Additional headwinds of falling demand and shifting behaviours mean full-year revenue growth is expected lower than the previously guided mid-teens, at around 10%. Underlying cash profit (EBITDA) margins will also come under pressure.

Full year revenue rose 7.2% to £2.5bn, reflecting a significant increase in International Solutions, as more Customer Fulfilment Centres (CFCs) came online. Five CFCs opened in the year, including two in the US. The core Retail business also grew. However, continued investment in the Ocado Smart Platform (OSP) meant pre-tax losses widened by £124.6m to -£176.9m.

Ocado expects Ocado Retail to ''return to strong mid-teens'' revenue growth in the new financial year. Capital expenditure is expected to rise around 18% to £800m to support ongoing OSP investment. No new Solutions deals were announced, Ocado is ''in conversation with a number of retailers and continue[s] to target further Solutions deals''.

The Retail business, which is half owned by Marks & Spencer, saw revenue rise 4.6% to £2.3bn, and is up over 41% on pre-pandemic levels. Revenue growth started to slow over the second half of the year as customers started to return to pre-pandemic shopping behaviours. All costs rose, including an £18m rise in marketing costs, plus higher labour and distribution costs. As a result, cash profits (EBITDA), rose more slowly than revenue, and was up 1.3% to £150.4m.

Increased capacity helped fee revenue in UK Logistics & Solutions rise 27.8% to £149.7m. Cost recharges, which includes costs recharged to the Retail business, relating to distribution costs, rose 4.4% to £560.7m. Increased fees from Ocado Retail and Morrisons helped EBITDA rise 54.3% to £68.5m.

The first CFCs in the US for Kroger went live in Monroe, Ohio, and Groveland, Florida, helping boost the International Solutions business. Revenue rose from £16.6m to £66.6m. Fees invoiced increased 15.4% to £143m. There was a total of £337.6m of fees not recognised as revenue because CFCs aren't live yet, at the end of the year.

There was a free cash outflow of £764.6m, including the acquisition of Kindred systems and Haddington Dynamics. Refinancing meant net debt reduced substantially and stood at £359.8m at the end of the year.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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 disclosure for more information.

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Written by
Matt Britzman
Equity Analyst

Matt is an Equity Analyst on the share research team, providing up-to-date research and analysis on individual companies and wider sectors.

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Article history
Published: 25th May 2022