Ocado eyes delayed gratification as losses grow

There was no confirmation of any new partnership with Marks & Spencer, as has echoed round the rumour mill lately, with chief executive Tim Steiner refusing to comment on a conference call with reporters. He said that the group was "constantly talking to different retailers around the world".

Such talks have led to lucrative deals signed by the Ocado Solutions business with several major overseas supermarket operators over the past 15 months, which has catapulted the shares 275% higher than they were two years ago.

While the FTSE 100 group's results revealed a sombre 2018 loss before tax of £44.4m, mushrooming from the prior year's £9.8m, this stems from the investment poured into the Solutions arm. Losses are expected to extend into 2019 as a result of this investment in the future as the potentially lucrative Solutions deals will not be able to generate revenue until their first 'Customer Fulfilment Centres' open and begin deliveries, due to new IFRS 15 accounting rules.

Until then, almost all turnover is from the UK-focused Ocado Retail business, which grew revenue 12% to £1.48bn, while Solutions took just £123m of sales, even though Bon Preu in Barcelona launched its online offer in November, Casino and Sobeys started building their respective first CFCs in Paris and Toronto, while ICA in Sweden and Kroger in the US picked out locations for their first sites.

Group earnings before interest, tax, depreciation and amortisation were down 21% to £59.5m as IFRS 15 calls for building costs of the CFCs to be recognised even though Solutions revenue has to wait.

Therefore, as was recently explained to analysts, EBITDA is likely to decline this year as no CFCs are expected to open in 2019 and Ocado cited £15-20m of additional operating costs necessary to prepare the CFCs and to provide features on the platform.

Cash, however, was burgeoning, with fees from Solutions partners in 2018 rising to £200.1m from £146.1m the year before, swelling the coffers to £410.8m at year-end.

Chief executive Tim Steiner said the 2018 performance of the Solution business was the culmination of the "18-year overnight success", but he added: "Our growth story, however, is only just beginning."

He continued: "Our transformation journey is well under way with increased cash fees earned and greater investment as we execute on behalf of our partners. Creating future value now will involve us continuing to scale the business, enhancing our platform, enabling our UK retail business to take advantage of all its opportunities for growth, and innovating for the future."

For 2019, he expects retail revenue growth of 10‐15% if economic conditions remain "broadly stable", thanks to increased fulfilment capacity, plus further retail EBITDA from the more efficient new CFCs up and running in the UK. Solutions revenue growth is expected to be ahead of Retail and new Solutions deals continue to be sought, which would generate additional cash fees but would impact short term profits.

Ocado also revealed that total capital expenditure for the group is expected to increase to £350m, from £213m last year and versus consensus expectations of £230m, reflecting the additional capital required as part of the overseas Solutions partnerships.

Shares in Ocado tumbled and then bounced on Tuesday morning, standing at 1,004p, up 1% after the first couple of hours of trading.

House broker Numis said EBITDA of £59.5m was equivalent to £73.9m before a £14.4m IFRS 15 adjustment and, therefore, slightly ahead of its estimate of £72.0m.

Numis noted that Solutions EBITDA declined by £12m to a loss of £17.9m as under accounting rules before IFRS15, an additional £15.2m of fee income would have been recognised, making the deals earnings neutral, as previously guided.

Analysts at RBC Capital Markets said revenue, EBITDA and PBT were "broadly" in line with expectations after taking into account negative impact from the adoption of IFRS 15, though Retail EBITDA margin of 5.5% was down from 6.0% the year before, which had been expected to hold firm.

"Ocado is the only global provider of an online grocery retailing end-to-end platform solution, which we view as the most robust and profitable. While we believe there is scope for further international deals, we think there is a great deal for management to now execute on and thus see a low likelihood of another major deal in the near term," RBC said, though it sees the shares as fairly valued.

Broker Peel Hunt noted that in the Retail arm, active customers were up +11.8% to 721,000, average 296,000 orders per week up +12%, 98.8% for delivery punctuality and average basket size down slightly to £106.85.

Laith Khalaf at Hargreaves Lansdown said that despite the transformational year its success won’t show in bottom line for several years to come, with no profit expected until 2020 and the shares one of the most expensive in the Footsie, reflecting the stock market’s forecast of stellar long term growth, which he noted had results in short positions in Ocado falling from 13% this time last year to less that 2%.

"The rocketing share price saw Ocado catapulted into the FTSE 100 last year, with the company now worth more than Marks and Spencer, which had a 116 year head start. There’s been talk Ocado and M&S may be hatching some kind of partnership, and that would make some sense for both parties. M&S basket sizes are relatively small, which makes the economics of online delivery particularly challenging. Clearly Ocado can help out here, though any tie-up would raise questions over its existing partnership with Waitrose, which comes to a close in 2020.

"Such high expectations baked into the share price raise the possibility of disappointment for investors. In this respect Ocado is similar to Amazon, which likewise comes with a lofty price tag as the market has pencilled in high levels of future earnings growth. We saw the extreme market reaction to slowing growth from such well-backed companies last December, when ASOS disappointed the market with only 15% sales growth, and subsequently saw its share price almost halve. For Ocado, the future looks extremely bright, but it still needs to deliver on very high expectations."