Despite presenting a set of financial results that showed spiralling losses before tax and a significant dip in EBITDA, Ocado’s chiefs are convinced 2020 will be the year its investment in technology is vindicated. Retail Week looks at whether their optimism is justified.

With insight from:

  • Ocado chief exec Tim Steiner on the next steps for the joint venture with M&S
  • Finance boss Duncan Tatton-Brown on the opportunities for international CFCs
  • Retail Week Prospect’s in-depth look at Ocado’s results since 2015

As he unveiled its full-year results, Ocado chief executive and co-founder Tim Steiner was at times defiant but often optimistic, particularly given that the business reported a deepened loss before tax of £214.5m and EBITDA slumped 27.3% to £43.3m.

Tim Steiner

Tim Steiner says 2020 will be ‘a landmark year’ for Ocado

But Steiner maintained the overall performance showed “the momentum that is now in the business and the progress that we’ve made over what’s been an extraordinary 12 months” – which includes the signing of two new Solutions clients, maintaining strong revenue growth and sealing a joint venture with Marks & Spencer.

Steiner can rightly argue that much of the loss was down to exceptional costs incurred as a result of the blaze at its Andover fulfilment centre.

Yet it is the great paradox of Ocado that, for a business that has been almost chronically shy of turning a profit in its 20-plus year existence, it remains a darling of the City.

Indeed, despite the increased losses incurred last year, Ocado’s share price has since risen by over 3.2%.

As Exane broker Andrew Gwynn noted, “numbers aren’t a big focus” for Ocado investors because “short-term profitability isn’t a concern” – investors, as with Amazon, have been willing to back a long-term vision of technology-driven success.

Shore Capital analyst Clive Black went further. He said: “If economies and the stock market were valued on the basis of the combined losses on huge investment and value destructing capital returns that Ocado has delivered, then we would all be flocking to Buenos Aires.”

Still, Steiner believes that 2020 will be “a landmark year” for Ocado – with the first two of its international customer fulfilment centres (CFCs) due to come online in the first half and the M&S joint venture scheduled to launch in September.

Is this finally going to be the year Ocado’s technology bet pays off in a way that is reflected in the financials?

Ocado losses widen after Andover fire, but retail revenues grow ahead of market

Ocado’s group revenue rose 9.9% to £1.76bn in the year to December 1, 2019, driven by an increase in the average number of orders per week, despite capacity limitations following the fire at Andover.

Retail revenue grew 10.3% to £1.62bn in 2019, as the result of increased order frequency and number of customers, though average basket size edged down 0.6% to £103.18. This compares to a 12% increase last year.

Ocado’s revenues have surged by almost 60% over the past five years as its retail operating base has continued to expand and its business model has evolved.

However, online grocery is costly, and the business has been increasingly loss-making since 2016/17 following increased investment in technology and fulfilment. The group reported a pre-tax loss of £214.5m in 2019, widening from £44.4m last year. This included exceptional charges of £94.1m, of which £88m related to the fire at Andover last February.

M&S investing 50% in Ocado’s retail business provides it with a much-needed boost.

Ocado’s retail business will operate as a joint venture with M&S. Melanie Smith joined as chief executive last September and has been building a leadership team ready for the switchover from Waitrose to M&S grocery deliveries from September. This is the first time M&S food will be available online and represents an opportunity worth around £7.5bn.

Revenue from Ocado Solutions and Logistics was up 7.8% to £583.2m. This now represents a third of the group’s business and includes fixed costs to Ocado Retail and Morrisons, as well as its deals with international partners Casino, Kroger, Sobeys, ICA, Coles and Aeon. This business remains fully owned by Ocado going forward.

Lisa Byfield-Green and Eleanor Smith, Retail Week Prospect

Overseas comes online

The first two international CFCs – one for Sobeys in Toronto and another for Casino in Paris – will be a big moment for Ocado.

Given the changes in accountancy practices prescribed by IFRS 15, the launches mean Ocado will finally be able to report the revenues from both of those CFCs rather than just count the costs.

The success of Ocado’s UK Solutions and Logistics arm, the domestic equivalent of its growing international division that reported a 25.7% rise in EBITDA for the year to £84.8m, points to the future profitability of the latter once it can get more CFCs operational, as chief financial officer Duncan Tatton-Brown explained.

He said: “Here in the UK, Ocado Group employs the drivers who deliver groceries and pickers working on our facilities. It’s a slightly different business, but the fact it generates a good level of EBITDA is illustrative of what will happen when the international business has scaled and matured.”

While Tatton-Brown would not be drawn on the future profitability of the international business, he said: “I can guarantee, in the next couple of years, we’ll be generating some quite interesting cash flows when these CFCs are open.”

However, the fact remains that in 2020 Ocado is forecast to spend an additional £600m in capex on the rebuild of the Andover warehouse, as well as on the construction of the 38 other CFCs around the world.

For Black, this means Ocado may once more have to go to the fundraising well for fresh capital.

Out on the range

A feather in Ocado’s cap will be the launch on September 1 of its retail joint venture with M&S.

Steiner said Ocado has been conducting research that shows “consumer preference is for the M&S lines over the Waitrose lines and that the pricing of M&S products is looking cheaper than Waitrose”.

Ocado van pink

Ocado will expand its product range once the joint venture with M&S launches

He also says Ocado will be “introducing several hundred new lines to make up for range gaps that currently exist in the own-label M&S lines versus own-label Waitrose lines”.

Of Ocado’s current range of 58,000 products, just under 4,000 are Waitrose products. When these are removed, Steiner says they will be replaced with “4,500 or 5,500” M&S products immediately, but he said the wider range would grow as more M&S lines are introduced.

“I’d expect our range to grow from 58,000 and I’d expect the M&S range to grow from 4,500 lines to 6,000 or even 7,000 lines in the future.”

Black points out that the revenue growth for Ocado retail is forecast at 10% to 15% for this year, which is an “encouraging” proxy for the launch of the new range.

However, he asks, given the capex outflow following on from “derisory EBITDA and more pre-tax losses”, what sort of return on capex can investors expect from the group?

“Time will tell. In the meantime, one has to hope Ocado can keep living the dream, execute perfectly and stay on the right side of good fortune,” he says.

While questions remain about Ocado’s future profitability, the fact remains that the City still loves a growth story and the online grocer-turned-technology provider is one of the most interesting stories around.

Broker Peel Hunt proclaimed that “2020 is going to be exciting” for Ocado. That seems beyond dispute. But as fellow broker Bernstein notes: “It’s all about execution now.”