With the ongoing coronavirus pandemic totally reshaping the way people shop for groceries and pushing hundreds of thousands of consumers online, how has the UK’s only pureplay grocer really fared in lockdown?
Ocado today updated the City with its results covering the lockdown, which saw both online grocery sales and demand surge historically.
While Ocado’s results covered the 26 weeks ending May 31, 2020, compared with Sainsbury’s and Tesco’s 16-week updates, they bear comparison as they take in the manic three-month period where grocery retail seemingly changed forever.
Ocado founder Tim Steiner was bullish about his business’ performance. More importantly, given the group’s increased focus on world domination through its technology Solutions arm, Steiner was also convinced that online grocery demand has passed the tipping point from which there is no return.
“In the last six months, the world has changed, and we aren’t going back to where we were before. We have seen two decades’ worth of growth in a matter of months,” Steiner says.
“This dramatic shift in online demand is not just a UK phenomenon – it’s happening everywhere.”
Yet Ocado has been criticised at home during this period for not being able to meet new customer demand. Its more rigid and capital-intensive automated warehouse model has also allowed the more nimble store-pick models favoured by the supermarkets to steal a march in terms of online share.
How, then, has it actually done?
Sales growth
Steiner hailed Ocado’s “resilience, dedication and innovative spirit” for the period, which saw sales balloon 27% to more than £1bn.
While the numbers in isolation may be impressive, they pale into insignificance when compared to the online growth of the likes of Tesco and Sainsbury’s.
In Tesco’s first quarter, overall ecommerce sales jumped 48%, hitting a peak of more than 90% growth in May. While not going into sales figures for the period, outgoing chief executive Dave Lewis said online sales this year would be worth £5.5bn, compared with £3.3bn last year.
Sainsbury’s, meanwhile, saw online deliveries skyrocket 87%, while sales more than doubled to be worth 18% of total group sales for the period.
Ocado’s share price today has dipped. GlobalData retail analyst Thomas Brereton notes that, while there are “numerous positives” to take from its first half, the retailer’s sales growth is basically as “good as it’s going to get”.
He points out: “Tesco saw +90% online grocery sales in May, and Sainsbury’s saw +136% in June – figures that are simply unachievable by Ocado due to capacity issues.
“With the UK online grocery market expected to grow 76.2% in 2020, Ocado will inevitably lose share of the UK online market.”
Ocado does offer partners a pick-at-store service, such as its tie-up with Morrisons, and Steiner said it had increased capacity in that area “fivefold” during lockdown.
However, he questioned whether the short-term increase in sales achieved by the likes of Tesco and Sainsbury’s over this period was sustainable.
“Could we have trebled our growth? Maybe five or 10 times? If we’d had the capacity, that wouldn’t have been difficult. But we’ll never know”
Tim Steiner, Ocado
Customer acquisition
Without the added lever of physical stores, Ocado has always been forced to rely on its ecommerce website to service customers. Early in the crisis, the sheer weight of new and existing customers trying to place orders saw the etailer close its website down.
With Ocado’s fire-damaged Andover CFC out of commission until the second half of next year and its Erith warehouse operating only at 60% capacity, Steiner admitted that the retailer had simply been unable to grow as fast as it could have.
“Could we have doubled, trebled our growth? Maybe five or 10 times? If we’d had the capacity, that wouldn’t have been difficult. But we’ll never know, not having had the capacity.”
In that time, Sainsbury’s and Tesco added hundreds of thousands of new online customers. Tesco’s Lewis said that, five weeks into lockdown, the grocer had the capacity to make 1.3 million deliveries a week, more than double where it started in March.
He also said the grocer served some 590,000 vulnerable customers online during the height of lockdown, many of whom were “new to Tesco”.
Sainsbury’s said it served more than 500,000 elderly, disabled and vulnerable customers online and boosted weekly delivery slots from 370,000 to more than 650,000. In its first quarter, online sales jumped 87% and more than half of its new online shoppers were also first-time Sainsbury’s customers.
Meanwhile, broker Peel Hunt notes that Ocado’s active customers for the period fell 14% to 639,000. Analyst James Lockyer says this “makes sense given the focus on loyal and vulnerable customers”, but does “put the revenue into perspective”.
Even as lockdown measures begin to ease, Steiner said that Ocado is still struggling to take on new customers. He says it currently has “over 1 million customers who want to shop with us” waiting for availabilities.
To mitigate this, Steiner stresses that Ocado will be increasing capacity by more than 40% by the end of next year – as new CFCs at Bristol, Purfleet and finally Andover come online, and capacity at Erith reaches capacity.
However, as Goldman Sachs analyst Ana Fernandez points out, delays to the building of the new CFCs could “negatively impact future demand from existing customers” and continue to hinder the acquisition of new ones.
This becomes even more important as Ocado’s joint venture with Marks & Spencer is set to go live this September.
M&S chair Archie Norman cautioned the retailer’s customers earlier this month that access to Ocado would “likely be very limited” due to the ongoing demand issues.
While Steiner admitted there could be more demand than Ocado can handle with M&S, “we know that we’ve got the code and controls in place to manage the business well in that scenario”.
Profitability of the model
The eternal question that has plagued Ocado is when it will become a routinely profitable business. In its 20-year history, it has only turned a pre-tax profit three times to date.
Steiner said that in the first half of the year its UK retail arm saw profits nearly double to £45.7m, despite increased costs from staff bonuses and absences and depressed margins. As a group, its overall losses before tax narrowed during the period to £40.6m.
However, improved retail profits were almost entirely offset by equivalent losses in Ocado’s Solutions business.
Despite all this, Steiner was adamant that Ocado’s automated warehouse model is more profitable than the store-pick models favoured by Sainsbury’s and Tesco.
“What you’re seeing from some of our competitors is that their numbers are challenged because of the growth of store-pick. Whereas what you’ve seen here is significant conversion to profitability in our retail business because of the operating leverage and the positive operating contribution in our model,” he said.
“I’d rather grow 40% with a doubling of profitability than grow 100% and wipe out my profits.”
While it is true that both supermarket giants noted that increased staff costs would likely wipe out much of the profits from increased online sales during lockdown, Shore Capital analyst Clive Black disagrees that Ocado’s model is more profitable long-term.
He says that Tesco and Sainsbury’s were able to achieve huge online growth with minimal capital investment, while Ocado’s warehouses cost tens of millions of pounds while still not delivering similar increases on returns.
“Making online profitable has always been a problem for the supermarkets, with the margins, but all big grocers have seen improved financial metrics during the lockdown. They are mostly in the black online, because at full capacity there’s no need for marketing incentives driving customers online,” he says.
“Supermarkets also increased capacity with minimum expenditure, while Ocado has put down tens of millions of pounds with desperately poor returns.”
Despite these criticisms, Steiner remains convinced that Ocado’s model will bear long-term fruit – both at home and abroad.
Ocado said that during the first half of the year international partner revenues had combined to £210bn, which, given the increased online shift globally, “represents a fee opportunity of £3.5bn to £26.3bn”.
Steiner predicted that online demand will continue to grow and could reach as much as 30% over the next five years, “at which point we’ll see a continued channel shift, which will begin to make the economics of stores quite challenging”.
Ocado has never been judged by investors like other retail businesses. It is built and sold on a singular vision and, if its online penetration predictions come true in the next five years, its failures over the last three months will be forgotten. As ever, though, it’s a pretty big if.
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