Ocado - OCDO (Hold)
Thanks for the suggestion @Master-Sharefu!
With COVID-19 sending the UK into lockdown, grocers have seen a massive uptick in orders and bulk buying. The frenzied buying behaviour has created unexpected volumes and logistical issues for several firms.
Ocado who have pioneered online grocer logistics and automation were in an excellent position to take full advantage of the panic buying. Does this translate into a stronger future for Ocado? Will they take these strong few months and convert the gains into something greater in the future, or have they wasted this lighting in a bottle moment?
What Does Ocado Do?
Ocado now considers themselves more of a technology company than an online grocer. What happened and what does this mean? Think about Amazon. They made their money as an online marketplace, while they were doing this they created new technologies and services to support their growth, these innovations were viable businesses on their own.
The story is somewhat similar but without the Amazon success story. Ocado’s focus has been on using technology to reduce waste, increase accuracy and speed, and ultimately create more margin where the industry couldn’t. Running a grocer chain is not a high margin business, Tesco has a 1.5% profit margin, so using technology and controlling the vertical value chain is a potentially untapped winner.
Source: 2019 Ocado Strategy
Retail, this is a D2C (direct to consumer) offering, currently, this is a partnership between Ocado and M&S. Originally offered in partnership with Waitrose. It’s a five-year joint venture where it’s expected that M&S will take over the venture and Ocado will move on.
Source: 2019 Ocado Strategy
UK Solutions & Logistics is all about white labelling their different technologies and services. For example, they have a joint venture with Morrisons where they offer the complete service on their behalf. Or they can offer their technology on a licence basis. Right now this makes its money from Ocado Retail (fees), a few select partners who use parts of their offing and Morrisons.
Source: 2019 Ocado Strategy
International Solutions is selling their technology and systems into new markets where Ocado doesn’t have a presence. This is highly speculative as they try to help a brand become a market leader with their technology (in terms of online ordering.) Ocado is still in the position where it’s cutting fees to win deals, this is a very long term business line.
Source: 2019 Ocado Strategy
Finally, we have the Innovation and Ventures arm of the business. As a tech business, they invest in small startups and future trends e.g. indoor vertical farming. There have a big interest in robotics and AI. Improving efficiency and accuracy while keeping costs as low as possible.
How Do The Fundamentals Look?
While COVID-19 has given Ocado a boost they are still recovering from a building fire last year.
With almost £100m in damages, plus lost business and stock, the insurancers have been slowly paying back the cost. The claim of £74m has been received and accepted, however, the last full year statement only £24m was recognised due to the payments being received over time.
Source: Genuine Impact Ocado
With a weak quality rank, a horrific value rank, they have a very surprising momentum rank. I’m keen to dig into the numbers behind the summary to figure out why the momentum is so high if everything seems to be priced in?
Source: Ocado 2019 Annual Report
Let’s pick out the key numbers here. £1.75bn of revenue, £1.164bn spent making that happen. Which still leaves over some money! Then we add the admin costs, distribution costs, and the joint venture loses. We end up with a £0.21bn lose before tax. With some creative accounting about their assets (warehouses, vans, and the insurance payout) we end up making £0.04bn. Not an impressive figure when you compare it against the headline.
However, this was the full 2019 report, we are one quarter in and we have been seeing in the news how successful Ocado has been. The issue is, we don’t have the quarter one numbers yet! So we are stuck with speculation. This goes a long way towards explaining the high momentum. Analysts are making predictions on the next quarter which we know should be better than expected.
Back onto the numbers we have. The profit margin is -12.06% (suddenly Tesco’s 1.5% doesn’t look so bad?), they don’t pay dividends, but they seem to be in control of their debt?
Source: Wallmine Ocado
As a company with lots of physical goods and assets, it’s much easier for them to appear more sound due to the amount of inventory and equipment they hold. The cash flow has also been recently boosted by the insurance payouts.
As the company isn’t turning a profit, they have increased sale volume but not profit, and good results are expected. The share price has rallied, which has completed destroyed the value metrics.
Source: Google Finance for Ocado
A price to sales ratio of 7.70 and price to book of 12.69, this is a stay away, red flag warning, for any diehard value investors. With so much expectation baked into the price, it’s going to be hard to increase the value but easy to have a disappoint that send it crashing back down.
With sentiment on our mind, and expectations. What are the sell-side experts saying?
Source: Genuine Impact Analyst Ratings
We are looking at a fairly even split, but with the Q1 announcement tomorrow, we are seeing a small shift towards a buy rating.
However, keep in mind this is being driven by higher than expected views on the revenue. We still aren’t seeing high earnings expectations or even a meaningful improvement in the target share price.
Source: Genuine Impact Target Price
Expected returns refer to the target share price and it’s increase versus the price now. The expected growth is the percentage growth for revenue and earnings.
With a very low target share price, we are at the high in terms of the current price. As there are no dividends to look forward to, you only have the share price increases as a way to make a profit.
Why A Hold?
I’m very much on the fence with this one. I would almost lean towards a sell rather than a hold. We are at an all-time high, it’s an expensive business which is heavily investing in speculative future bets, and we are still recovering from the 2019 fire.
Ocado is also in proceedings against T0day and others for IP theft, which is currently a negative on their balance sheet due to legal fees. The cash injection with the partnership (over £500m from M&S) is nice but we’ve seen their ventures cost as much as they make.
I wouldn’t be in a rush to sell off my Ocado shares, they are an interesting and innovative company, but if you want to free up some capital this would be a prime target in my mind.
If you don’t hold Ocado I would not consider this as a purchase right now. Wait and see for the announcement tomorrow, and see what the new estimates and growth looks like post-COVID-19.
Let me know your thoughts! Have I missed anything you wanted to cover, or maybe some more information you want analysing?
Thanks for reading and stay safe!