Ocado has today reported a big slump in half-year profit – yet the City remains, for now at least, fairly sanguine.

Putting a brave face on what would have been – for any other retailer – an absolute shocker of a first half of the year, Ocado boss Tim Steiner said that the etailer-turned-technology business has “never had as many opportunities to grow as we do today”.

In the 26 weeks to June 2, 2019, Ocado saw its EBITDA dive 46.3% to just £18.1m in adjusted terms, despite a 10.5% increase in group revenue to £882.3m.

While the declines appear eye-watering, there are reasons behind them. The lion’s share comes from writing-off Ocado’s Andover facility, which was destroyed by fire, while changes in accounting practices mean future profits cannot yet be recognised but upfront costs must be. So the expenditure it is making on the numerous distribution centres to power its potentially lucrative tech tie-ups with grocers such as Kroger, Sobeys and Casino must be accounted for.

Also, the slew of international deals the business has signed of late means its managers have received a larger than expected bonus package.

Free pass

Despite the profits plunge, it seems most shareholders and the City broadly agree with Steiner’s confident prediction.

The etailer’s share price rose by 6% this morning, as investors chose to focus instead on the group’s aforementioned potential for almost unlimited future growth off the back of the host of technology deals it has struck over the last 18 months.

Indeed, since inking its first and long-awaited overseas deal with Canadian grocer Sobeys in 2017, Steiner and Ocado have bet big on technology.

In the first half of this year alone, Ocado signed a £750m joint venture with Marks & Spencer and a tie-up with Australian grocery giant Coles, which will see it build four customer fulfilment centres

It is because of deals like these – and the acquisition of stakes in futuristic food enterprises such as automated meal preparation firm Karakuri and Europe’s largest vertical farm provider Jones Food Company – which continues to keep the business’s market valuation high, despite it leaking cash.

“Ocado was always likely to get a ‘free pass’ on both its second-quarter and half-year results due to the fire”

Investors were also forewarned to expect trouble, given that Ocado had forecast that it would incur heavy losses from the catastrophic fire which tore through its state-of-the-art Andover customer fulfilment centre in February.

As Exane analyst Andrew Gwynn put it, Ocado was always “likely to get a ‘free pass’” on both its second-quarter and half-year results due to the fire, which has seen it incur costs of £110.3m, only £11.8m of which has so far been offset by insurance for its warehouse blaze.

Its solutions technology business, which also registered EBITDA numbers below many analysts’ expectations due to the loss of its Morrisons fees, has also seemingly been overlooked. It reported a £16.2m loss during the period.

As a result of the fire and the costs of covering larger than expected management bonuses, Ocado’s house broker Numis said that full-year earnings would likely be down by £20m or even £25m below what analysts were expecting.

While Steiner and Ocado finance director Duncan Tatton-Brown were keen to flag that Ocado is soon to have “£1bn of headroom” to play with when M&S’ initial upfront £562.5m joint venture cheque clears; that money has already been allocated to building the 34 customer fulfilment centres it is currently committed to developing at home and abroad.

Testing the City’s patience

Despite all this, the market remains nonplussed.

Investec equity analyst Ian Hunter perhaps put it best when he said “the Ocado story is one of longer-term growth expectations in the solutions business as the global customer fulfilment centre development programme rolls out, rather than short-term performance in the UK-based retail business as it rolls in a joint venture with M&S”.

But how much more rope will investors, and the City, be willing to give Ocado in future?

“Ocado has yet to build warehouses for retailers in the USA, Canada, Sweden, France and Australia”

Since launching in the 2000s, Ocado has only ever turned a pre-tax profit twice in its 18-year history.

As things stand, Ocado has yet to build warehouses for retailers in the USA, Canada, Sweden, France and Australia. This will be timely and expensive and is likely to inhibit profits in years to come.

With so much of its working capital, and the prospect of any future profits, tied up in its technology arm, next year is set to be make-or-break for Ocado and its future. The first of its international depots – with Kroger in the US – is set to come online in 2020 and Ocado will be looking forward to getting motoring.

Shore Capital analyst Greg Lawless agrees and says: “Given the high valuation of this technology platform, there will be a need for flawless execution for the company to sustain its premium rating.”

There’s clearly plenty of upside for Ocado and Steiner has so far been able to get the City to believe in his vision. However, if Ocado doesn’t begin turning a profit sooner rather than later, investors may grow weary of waiting for the long game.