Fundamental Analysis of Ocado - Already at it's peak?

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!

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Really good read, thank you for the write up. I personally never bought Ocado and was on the fence as I know someone who works for them and recommended buying into them a few years ago. Will see if the share price goes up or their expected revenue is already priced in.

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Thanks for the kind comment!

I actually heard something similar. A friend was looking at getting a job at Ocado Group in their AI space and was very hyped on the company. I did point out they struggle financially but he was convinced that the larger group was fine.

I’m sure the company is doing OK to keep ticking by, but as an investment to maximise my returns, I prefer something a bit more exciting.

I also didn’t know about the M&S Ocado venture will be all owned by M&S after five years. I don’t know if this means M&S will have their own Ocado online white label (like Morrisons) or they are interested in taking over Ocado Retail. Five years is a long time and Ocado want’s to be a technology company, but that’s something I’ll be keeping an eye on.

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I also appreciate your write ups on Freetrade forums as well, very helpful and insightful. Keep doing what you’re doing please.

I think Trading212 community forums lacks that level of interest and insight.

Back to Ocado: I think it will be a fierce competition in the market going forward as a lot of companies are reassessing their roadmap in order to adapt and get a pie from the market.

A good example will be Lidl, where they look to challenge Amazon in the cloud security space and considering if they will have the tech they won’t be far from doing online shopping and such. Can’t believe I’m writing this in this timeline, Lidl to rival Amazon in AWS space.

http://staging.chargedretail.co.uk/2020/05/11/lidl-owner-launching-its-own-rival-to-amazon-web-services/

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Thanks!

I like to post in a few places as I get different feedback. I did one post on Reddit which got a lot of critical but very insightful feedback. A bit of tough love by my style has gotten better (I hope) since then. Plus it’s nice to soundboard how I approach things.

I found the Lidl news to be confusing. Almost the cart before the horse. They know they are building out some impressive tech and cloud structure, and they are rolling it out while also proving they can do it themselves.

Given the fact giants like Netflix are big users of AWS, and helped defined what have become common features on AWS now, makes me wonder what hope Lidl have of competing and what are they bringing to the table which no one else has done before.

Its already a really competitive space!

Also, your link goes to the staging site rather than the public live one! But the article is very interesting.

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