Ocado turns up volumes but margins remain under pressure

Ocado claimed its best quarterly volume growth in four years, although a slight acceleration in group revenue growth in the third quarter thanks to the Morrisons deal was overshadowed by comments about the tough margin environment.

Average order size also continued its decline and there remained "sustained and continuing margin pressure", said chief executive Tim Steiner.

House broker Numis said it understood that as items per basket and mix were largely unchanged, it suggested this was largely driven by the ongoing industry-wide price competition.

Gross group sales grew 15.4% to £314m in the 12 weeks to 7 August, up from the 15.1% growth in the first half of the year.

This was helped by 18.9% growth in average orders per week to 226,000, its best performance for five years.

But Ocado brand retail sales, which includes its Fetch, Sizzle and Fabled sub-brands and excludes the deal with Morrisons, grew 13.6% to £286.4m, which was down moderately from than the 13.9% from the first half.

Customers' total average basket including standalone Fetch, Sizzle and Fabled orders declined by 4.5% to £105.57, at the group level by 3.4% to just under £108.

Steiner said: "As the market remains very competitive, we are seeing sustained and continuing margin pressure and there is nothing to suggest that this will change in the short term.

"However Ocado's combination of choice, competitive pricing, and industry-leading service has contributed to an increase in average orders by nearly 19%, our best volume performance in more than five years."

As at 7 August 2016 the balance sheet showed cash of £48.1m and external debt of £86.5m.

House broker Numis argued that the record rise in volumes suggested there was "no noticeable impact from the nascent
Amazon Fresh operation, which recently doubled its postcode footprint".

But while revenue estimates were left unchanged, analyst Andrew Wade cut his full year forecast for earnings before interest, tax, depreciation and amortisation (EBITDA) to £85.1m from £87.5m previously, "recognising that the industry-wide pricing pressure on basket size is likely to weigh on gross margin and opex ratios". This means his earnings per share estimate falls to 0.89p from 1.2p.

Independent analyst Nick Bubb said that Steiner's comments on margin would drive headlines and brought up another source of pain for management.

"The Q3 update from Ocado has given the hard-working management yet another opportunity to announce the long-awaited overseas licensing deal, but, needless to say, the silence is deafening," Bubb zinged.

Analyst George Salmon at Hargreaves Lansdown agreed, although in a slightly more forgiving fashion, noting that "despite providing a fantastic service and growing the top line strongly, Ocado makes relatively little money", meaning more deals are needed in order to justify the shares’ lofty valuation.

He added: “There aren’t many retailers who can turn a blind eye to Amazon turning up in their back yard, and Ocado are no exception. Despite higher sales and order numbers, competitive forces are likely to keep margins under pressure for some time.

"In fact, Amazon’s entry into the already tough food retail market is something of a double blow, as Amazon was once a potential suitor for Ocado but has chosen to partner with Morrison instead."

Shares in Ocado, which is one of the most shorted stocks in London, were down almost 12% to 284.8p after an hour of trading on Tuesday.