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Ocado - new partner for the Solutions business

Ocado has confirmed a new partnership deal between Ocado Solutions and Lotte Shopping

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Ocado has confirmed a new partnership deal between Ocado Solutions and Lotte Shopping. Lotte Shopping, the largest retail affiliate of Lotte Group, operates in South Korea, with more than 1,000 stores nationwide and an annual revenue of 15.6trn KRW (£9.5bn).

The agreement plans for the development of a nationwide fulfilment network, with 6 Customer Fulfilment Centre's (CFCs) planned by 2028. The first CFC is due to go live in 2025, with in-store fulfilment software rolling out in 2024.

Lotte will pay Ocado Solutions certain fees upfront and during the development phase, then ongoing fees linked to both sales and installed capacity within the CFC and service criteria.

Ocado doesn't expect to need additional financing and sees no material impact on current year earnings. There's expected to be a small capital expenditure increase next year, with the majority expected in the 12 months prior to the opening of CFC's.

The shares rose 22.0% following the announcement.

View the latest Ocado share price and how to deal

Our view

Ocado's business essentially comes in two parts, the retail arm (more on that later) and the solutions business. It's the latter grabbing the headlines and why the Group's downtrodden shares received a sentiment boost on news of a new partnership deal.

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 turbo charged the shift to online shopping, increasing demand for the kind of technology Ocado specialises in. It's a very different environment now though, the weakening economic outlook comes as somewhat of a double-edged sword. On the one hand it puts pressure on existing and potential partners to cut unnecessary spend. On the other, running operations through Customer Fulfilment Centres (CFCs) brings a host of cost savings and efficiency benefits which could offer a unique competitive advantage for those who can afford to take the plunge.

The recent partnership deal with Lotte, a large player in South Korea, showed markets that there are still businesses happy to take those benefits, despite a weakening economic outlook. That's promising.

But servicing expansion plans comes at a cost, with Ocado stumping up hundreds of millions to fund CFCs. The group tapped investors for a touch shy of £600m earlier in the year. There're no immediate concerns, and management's been clear it doesn't see any new capital being needed anytime soon. But if tough cost conditions persist, we can't rule out Ocado burning through its available liquidity faster than planned.

Ocado Retail - 50% owned by Marks & Spencer - is the business behind the delivery vans you'll see on roads nationwide. The economic backdrop means customers are tightening their belts in a big way. Ocado is hardly a discount name, so this trend has a disproportionally big impact.

More concerning are the ever-increasing cost pressures. Ramping up output is expensive, especially when you add in the skyrocketing impacts from higher utility and staff costs. We think the weaker sales outlook will persist for some time, which together with these rising costs means profits are going to be thin on the ground for as long as that's the case.

We should be clear - Ocado has an 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.

For now, thin profits make Ocado hard to value but on a share price to sales basis, expansion costs and execution risks are being heavily priced in. The group now trades a decent way below its longer-term valuation. We share the cautious sentiment given the uncertain market in the near to medium-term.

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.

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: 1st November 2022