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Ocado still a lemon

Ocado is losing share as its competitors get their acts together - and the long-term picture is far from clear
June 7, 2012

Since its controversial initial public offering (IPO) two years ago, Ocado has spent most of its life as a quoted company batting away criticism from those who question whether its business model is viable. That includes ourselves - we advised readers to steer well clear of the flotation - and, several profit warnings later, we haven't changed our view.

IC TIP: Sell at 106p
Tip style
Sell
Risk rating
High
Timescale
Long Term
Bull points
  • IT problems fixed
  • Second warehouse on track
Bear points
  • Growing more slowly than competitors
  • Could need further financing
  • No finance director
  • Unlikely takeover target

If anything, the outlook for the online grocer has worsened since the IPO. Technical issues at its state-of-the-art distribution centre meant sales growth slumped to just 10 per cent over the key Christmas period. These problems have now been largely rectified, meaning sales growth has recovered to a more respectable 13 per cent and should hit 18 per cent by the fourth quarter. But that's still lower than the internet businesses of rivals such as J Sainsbury and Asda, both of which are growing at 20 per cent despite already selling more groceries online than Ocado. Waitrose is growing its online business faster still, with sales up 26 per cent last year - that may be from a smaller base, but it's more worrying because, with Ocado distributing Waitrose products, there is likely to be significant customer overlap between the two grocers. Ocado has now developed a range of over 600 own-label products, but that's still significantly fewer than other mainstream grocers.

Ultimately, this means Ocado is losing share in the highly competitive online grocery market, a sign that, with competitors getting their acts together online, the advantage it once enjoyed in terms of the quality of its service is narrowing. It also means that the case for a second £200m customer fulfilment centre (CFC), which is on track to begin operation in the first quarter of 2013, isn't that clear cut. Ocado is yet to make a pre-tax profit from one centre that is approaching capacity. There will certainly be some economies of scale from a second centre, and a reduction in delivery costs to more northerly customers, but it will presumably take some years for it to reach a level of sales that will cover the additional running costs.

OCADO GROUP (OCDO)

ORD PRICE:106pMARKET VALUE:£555m
TOUCH:106-107p12-MONTH HIGH:231pLOW: 52p
DIVIDEND YIELD:nilPE RATIO:212
NET ASSET VALUE:33pNET DEBT:11%

Year to 27 NovTurnover (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
2009402-25.5-6.10nil
2010516-12.2-1.63nil
2011598-2.42-0.10nil
2012*687-2.60-0.50nil
2013*8242.700.50nil
% change+20---

Normal market size:11,000

Matched bargain trading

Beta:1.66

*Shore Capital forecasts

Of course, if Ocado wants to compete in grocery it needs to build warehouses, because unlike mainstream rivals it can't pick web orders from existing stores. Unsurprisingly, Ocado has often argued that its automated method is better, but the fact that no other grocer has felt the need to introduce the degree of expensive supply chain complexity at the heart of Ocado's CFCs suggests the advantages are anything but clear. The preferred solution adopted by Tesco is to add capacity in areas where online orders are high by building so-called "dark stores" - essentially supermarkets dedicated to online order-picking.

Ocado's complexity is also why we think that talk of a possible bidder is wide of the mark. For large retailers with well-established online operations, it would be difficult to integrate Ocado's systems. Waitrose would seem a logical buyer, given its distribution relationship with Ocado, but having already sold its entire stake in the business, it is unlikely to make a move, especially as its own online expansion is already well under way. And while neither Marks and Spencer nor Morrison currently has an online capability, both are likely to go down a more organic development route having bought in the necessary expertise.