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Smart Investor: will Ocado ever deliver?

Upmarket online grocer Ocado (OCDO.L) has huge potential, but can it turn a profit? Smart Investor gives his take on the prospects for the shares.

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by Smart Investor on Oct 11, 2012 at 06:58

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Smart Investor: will Ocado ever deliver?

FTSE 250-listed Ocado (OCDO.L) divides opinion. Supporters of the UK’s only dedicated online supermarket say the company has the scope to revolutionise the way that people buy their groceries, and that a few difficult years will soon be forgotten once Ocado delivers on its vast potential.

Others, however, see a delivery company that calls itself an online supermarket offering customers a fair deal and investors a raw deal, as the company has yet to deliver anything but groceries (and certainly not a net profit) to investors.

Ocado’s story began in 2000 when three former investment bankers began delivering Waitrose goods within a small area near St Albans, Hertfordshire. The operation expanded rapidly and soon Ocado’s delivery area had grown to more than 10 million households.

Waitrose remains the major supplier, with the two companies signing another 10-year agreement in 2010. Today, Ocado employs more than 5,000 people, makes 18,000 deliveries per day and, with a market capitalisation of £342 million, is the 345^th-biggest UK listed company.

Performance review

In terms of performance, the past five years have been disappointing. As mentioned, Ocado has yet to make a net profit. Its website lists various milestones such as ‘Ocado became earnings before interest, taxes, depreciation and amortisation (Ebitda) positive in 2007’ and ‘Ocado became pre-tax earnings positive for the final quarter of 2010’, but these are hardly major achievements.

Any company in the world is ‘profitable’ if you look far enough up the profit and loss sheet, before too many costs have been deducted from revenues.

So, no return on equity or net profit growth rate can be analysed. Of course, Ocado’s marketing department will point out that the company made a net profit of £181,000 for the first half of the current financial year. However, this works out at just £36.20 per employee over the course of 24 weeks. As for a yield, the word ‘dividend’ is mentioned 41 times in the 2011 annual report, but shareholders are still waiting for one.

Debt pile

Meanwhile, Ocado’s debt levels are fairly moderate at 28.4% using the debt-to-equity ratio. However, a lack of profitability means the company struggles to service this debt, with interest cover being just 1.1 and a hefty finance lease liability significantly adding to finance costs too.

Furthermore, the company appears to lack even the most basic of economic moats. Customers may argue that it provides a very good service and sells quality items at fair prices. However, an investor needs far more than this; barriers to entry, resilience in tough trading conditions, product differentiation, pricing power and brand loyalty are required by investors but not offered by Ocado.

Of course, a true cynic would argue that Ocado benefits from the ultimate barrier to entry. Why would anyone want to enter an industry in which the major player has never made a profit?

The verdict

With shares currently trading at 65p, Ocado’s price-to-book ratio is 2.1 and its price-to-earnings (P/E) ratio is negative using 2011 earnings per share figures. The shares have been as high as 285p in February 2011, and have traded between a low of 58p and a high of 132p in 2012. Needless to say, shares do not offer good value at current levels.

Indeed, it seems Ocado still believes that potential, and not profits, is always the answer to criticism when, in reality, losses are the capitalist world’s way of telling a company that it has failed. Ocado may offer its customers a fantastic service but, unfortunately, it seems to only be able to do so on a not-for-profit basis.

Supporters of Ocado may argue that the company is 10 years too early, that the UK is not quite ready for an online only grocer that undoubtedly has major green and environmental credentials. However, it seems to me that Ocado is actually 10 years too late. The tech bubble, when companies making no profit but with great ‘potential’ were trading at ridiculous prices, burst over a decade ago.

Can Ocado turn its fortunes around? Maybe, but the chances of it doing so are too slim and the cost of taking the risk far too high for Ocado to be a realistic investment opportunity.

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9 comments so far. Why not have your say?

No - can't recommend a purchase.

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How can they retain a USP when their competitors have such vast resources and deep pockets. A faster moving smaller company maybe???

Ocado have done well but I believe their future can only point to them being purchased by a bricks and mortar retailer. This would offer the BOD a good return and an upside for the share holders.

A purchase would only be warranted on this basis, but would be a hairy ride until that day comes.

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OK lets look into a crystal ball for a moment. In every street in the UK there are an increasing number of home deliveries to fulfil internet sales. Repeat deliveries, returns all goverened by individual rules and disperate locations for DHL, DPD, Post Office etc. This trend will continue. Currently there is no organisation acting as a hub for internet vendors but this is the logical extension to the current inefficient and rather chaotic service to the internet customer. Someone will provide that service soon, enabling internet customers to nominate their preferred delivery service. Currently OCADO has it's nose in front to secure this opportunity in the UK but if the Amazon Marketplace decided to extend it's service to click and collect shops and home deliveries they would probably clean up. The current apparent plan for OCADO's organic growth via developoment of fulfilment centres looks encouraging but they will need to extend their range beyond fresh foods and support many more internet vendors if they want to optimise their delivery service. They should also provide a click and collect service from smaller, accessible outlets (eg. by renting space from DIY superstores) to complete the picture of future retailing. The exponential growth of internet sales still has some way to run so now is the time for the winners to get those plans in place and investment underway.

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The retailing market overall is going through difficult times and will it seems continue to do so. Added to that retail commodity prices, as well as energy continue to add to that burden on retailers. So what else is suffering as a result of economic, global and European difficulties? Many other sectors of the economy.

So Ocado like many is suffering. In addition there seems to be a never ending stream of negative voices on the OCADO channel

I don’t hold, not only because I have no spare in my portfolio. But look at the other bad news hitting the sector Morrissons, Tesco etc.

But I do shop at Ocado; I like it as do many others. And see its Customer style and retail competiveness, as well as its method of operation, attractive. Do I really pay more for what I get-- I don’t think so.

So maybe when and if UK Plc gets into a higher gear, this retailer will shine and achieve profitability as well.

But it would be nice to see some back off a little with the Negative approach-- or does somebody have an agenda ?

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Sitting at home with my foot up after a foot operation, I have just done my weekly shop online for the first time. But did I use Ocado? No, I went direct to Waitrose, because I trust them.

That is the basic problem with Ocado - I can't see where it fits into the online supermarket business. I suspect I'm not the only one with that view.

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Ok Maverick- well if it was a reasonable size shop , tell me how many substitutions you receive. The advantage of Ocado if you are within their distribution network is that they operate from large centres, not an individual shop. Also ocado has a contract with Waitrose and their items can be purchased via Ocado . Just use Ocado software and browse their range. My last shop with Waitrose 7 substitutions.

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Have found Ocado excellent for Waitrose products for some time. Recently tried Waitrose own delivery service because of a promotional offer and the timing of the deliveries has been nowhere up to Ocado's standards. I am back to Ocado for groceries but not saying I would buy their shares!

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Ocado shopping is a good experience for customers. It is incredibly efficient and employs drivers who all are not merely polite but helpful cheerily fetching groceries right into the house. Substitutions are rare and accepting them or not is a simple choice on the doorstep. You may not be able to pick the best lettuce off the heap but quality is good. They do occasionally send something damaged because of bad packing (squashed bread loaves for example) but are prompt to refund on complaints. If style counts they have absolutely the right formula but I don't envy their motor fuel bill.

This is a superb business. Tragic if it is handicapped by lack of massive profits.

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Franco

Oct 13, 2012 at 13:04

Any internet grocery shopping is better than Tesco.

Their packed vegetables are listed without any weight indication and most frozen packs are not shown as such. So you can easily order potatoes and get frozen ones delivered. By the time you realise hat has happened, the driver has gone. Ah, well, such is life !

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