Ocado Group plc (OCDO) Ordinary 2p

No recommendation - No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Ocado shares fell by 20% on 12 September, after its major US supermarket partner Kroger held an earnings call the previous evening.

In 2018, the two firms agreed to build 20 fulfilment centres where automated robots sort orders using Ocado’s technology. Eight fulfilment centres have been built so far, with two more scheduled for this financial year.

However, during its earnings call, Kroger stated that it is looking at ways to cut costs, “including a full site-by-site analysis” of its automated fulfilment networks. Instead, Kroger could look to use its own stores to deliver groceries faster.

The shares were broadly flat on 15 September.

Our view

Ocado’s shares fell sharply last week as its major US partner Kroger announced it’s reassessing the future of its automated warehouses. These currently rely on robots to sort orders using Ocado’s technology, and any winding back of this partnership would likely weigh on Ocado’s future growth.

Some of its other retail partners have also been having second thoughts about opening more Customer Fulfilment Centres (CFCs). That’s seen analysts trim their expectations for future growth, leaving the Group’s path to profitability a little unclear and denting investor sentiment.

CFCs are the cornerstone of Ocado’s Technology Solutions division. The group charges third-party retailers to use its robotic systems. Hundreds of thousands of orders are processed each week, with the help of automated 'bots' scurrying around the trademarked grid systems.

Running operations through Customer Fulfilment Centres (CFCs) brings a host of cost savings and efficiency benefits that could offer a competitive advantage for those who can afford it. But the current economic outlook poses challenges, putting pressure on existing and potential partners to cut unnecessary spending.

There’s also pressure to establish a long runway of CFC openings because Ocado is stumping up hundreds of millions to fund these centres. This has led to significant fundraising from shareholders. Medium-term plans for free cash flow generation from existing CFCs seem ambitious to us, and we can't rule out Ocado burning through its available liquidity faster than planned.

Ocado Retail, the grocery delivery business half-owned by M&S, is doing well. Customer numbers have shot past the million mark, and volumes are improving as a result. In part, that’s thanks to M&S’ improved quality and value perception, which helps to lure more customers onto the website.

Ocado’s striving to expand its product range, increase delivery slot availability and is investing in keeping prices low to prevent customers switching to competitors. While we’re positive about progress, we must point out that this division is still loss-making and there’s no timeline for reaching the land of profitability.

There’s also potential legal action with M&S over a withheld £190mn performance payment, after pre-defined targets weren’t met. The saga remains ongoing and it’s something we’re following closely. Regardless of the outcome, it’s hard to imagine it will benefit relations.

We should be clear - Ocado has an amazing product. However, the group is still loss-making. As it builds scale and partnerships mature, profits and free cash should flow. We just aren't convinced this will happen in the projected timeframe. And if partners cut back on CFC expansion plans, it could further damage the valuation, which has already fallen significantly in recent years on a price-to-sales basis.

Environmental, social and governance (ESG) risk

The retail industry is low/medium in terms of ESG risk but varies by subsector. Online retailers are the most exposed, as are companies based in the Asia-Pacific region. The growing demand for transparency and accountability means human rights and environmental risks within supply chains have become a key risk driver. The quality and safety of products as well as their impact on society and the environment are also important considerations.

According to Sustainalytics, Ocado’s management of ESG risk is average.

The group has an adequate environmental policy and its whistleblower programme is strong. However, ESG reporting falls short of best practice and the group lacks regular risk assessments on data privacy.

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.

Previous Ocado Group plc updates