Confiture tomorrow: Ocado signs long-awaited first overseas deal

Long a Square Mile joke for its 'jam tomorrow' optimism of signing a major deal overseas, online grocery specialist Ocado on Sunday has proved its doubters wrong by winning a contract with a regional European retailer.

Ocado, which has chosen not to name its new client, said its new partner has signed up for help in setting up an online grocery delivery service using the FSTE 250 company's proprietary software and support services.

Although he has won contracts with Waitrose and more recently Morrisons in the UK, Ocado's bullish chief executive Tim Steiner has for some years been mocked and maligned in the City for trumpeting that a major overseas deal was in the pipeline though it never seemed to emerge, which when combined with Ocado's high valuation has seen the shares often among the most shorted in the FTSE 350.

In the announcement on Sunday, Steiner confirmed the Ocado Smart Platform will enable the European retailer to supply orders initially fulfilled from its own company's manually operated centralised warehouse.

"The agreement gives the partner the right to request in the future the installation of automated mechanical handling equipment in centralised warehouses, powered by OSP technology, on terms to be separately agreed but within given parameters."

The deal will see Ocado receive an up-front fee for access to the platform, together with ongoing fees that are based on the volume of products sold online.

Ocado expects the arrangement to be earnings and cash neutral in the current and 2018 financial years, "and increasingly accretive thereafter".

The retailer apparently "wishes to remain anonymous until it launches its online business in order to retain competitive advantage".

Said Steiner: "This is an exciting step in the evolution of our business and in the delivery of our strategy.

"The benefits of our integrated solution are clear. As this particular retailer looks to develop its online offering the agreement we have signed provides the flexibility to expand its capacity efficiently in the future. We look forward to working closely with our new partner in the months and years ahead.

"Our discussions with other retailers across the globe are ongoing and we continue to expect to sign multiple deals in the medium term."

When asked by the Sunday Telegraph if the agreement was transformational for the company, chief financial officer Duncan Tatton-Brown, said: “I think what’s clear is this is an exciting step forward, but are we at the end of the race? No clearly not.”

He added that Ocado was still in talks “with lots of other retailers and we continue to expect that we’ll sign multiple deals in the medium term”.

REACTION AND ANALYSIS

Shares in Ocado spiked to a year's high of 340p in early trade on Monday.

Independent retail analyst Nick Bubb said for one of the most shorted stocks in the market, the Ocado share price has had a remarkable run in recent weeks, with a rumoured-and-then-denied deal with M&S.

"But a modest software deal with 'a regional European retailer' -- without any central warehousing -- is hardly the big deal that the share price run has been discounting, so there may well be some profit-taking once the City has digested the deal and the shorts regain their nerve."

Andrew Wade at house broker Numis was very encouraged by this announcement.

"While it may not be a ‘blockbuster’ MHE [mechanical handling equipment] deal with a major incumbent grocer (we have no idea from the announcement, but suspect not), it demonstrates unequivocally that there is demand for Ocado’s OSP offering – enabling retailers to rapidly and seamlessly scale from scratch to a best-in-class online grocery business."

"This deal demonstrates that there is clear value in the end-to-end solution being offered by Ocado, not just in the automation/IP housed within [its new customer fulfilment centres). Coming just a few months after the appointment of Luke Jensen as CEO – Ocado Smart Platform, suggests that Ocado is benefiting from additional resource in this area."

George Salmon at Hargreaves Lansdown said the news that a European retailer has signed on the dotted line is what investors have been waiting for, and is a major fillip for the company, even if we don’t yet know who this deal is with, or indeed how much it is for.

"That the whirring equipment in Ocado’s distribution centres is a technological wonder has never really been in dispute, but this hasn’t stopped there being plenty of debate around the group’s potential profitability. It might be ahead of its rivals in terms of service, but the fact is that organic growth alone doesn’t justify the shares’ premium price to earnings ratio.

"The high valuation reflects the potential for the group to licence out its intellectual property to others, which in turn opens up the possibility of raking in chunky royalties year-in-year-out."

Some analysts could not resist a few more digs.

While it was good news that Ocado has managed to fulfil a long-standing but thus far unfulfilled pledge, Clive Black at Shore Capital said Steiner "remained a person of international intrigue and mystery" for not naming of the new cross-channel partner: "Could be we packing our bags for an international day out in Albania, Kaliningrad or a tour of Poland?"

While the agreement is hoped to be a stepping stone to a flood of announcements in due course, Black noted Ocado's "poor financial track record, derisory earnings and failure to pay a dividend over 17 years whilst being rescued twice" as probably still weighing on potential partners' minds.

"Whilst seemingly small cervesa, or is that biere, in the big scheme of things, we advise that Ocado shareholders' do keep in mind any cash flow implications from this potential tie-up and any further ones, including the build out cost of its UK network. Ocado continues to consume a lot of cash. The group has c1000 technologists, the cost of which is being capitalised, whilst building out customer fulfilment centres means that cash burn remains strong. Hence, net debt is rising once again, after the injections from its last rescue fund raise," Black added.