Ocado earnings to take up-front hit on overseas contracts

Ahead of final results due on 5 February, chief financial officer Duncan Tatton-Brown gave a presentation to explain the impact of the FTSE 100 company's decision to employ the IFRS15 accounting changes from its full year ended November 2018.

Tatton-Brown helped to clear up uncertainty about the economics of the Customer Fulfilment Centres that Ocado's Solutions arm has begun building under the five international deals it has signed, including for Kroger in the US and Casino in France, said Bernstein analyst Bruno Monteyne.

Monteyne said that previously "nobody knew for sure how high the capacity fees would be", but there were sufficient numbers provided in the presentation about the cash fees of a CFC so that it was possible to "back-solve" for the capacity fees, which he calculated should be between 3.5% and 6.85% of sales capacity.

"These aren't exact numbers but they finally clearly pin down the range of possible economics," he said, adding that his bullish view on the company, including a 1,300p price target, is based on the lower end of this range, 3.5%.

In other words, he believed his forecasts for the future EBITDA and cash generation of the Ocado Solutions business "may be much too low in future years" and that cash economics "may be better yet".

Tatton-Brown also explained that, as with other companies employing the new accounting standards, the inflow of cash to Ocado from the overseas deals will not be impacted in its accounts but that revenue that the company had initially said would be recognised in the two years before the warehouses become operational will now not be recognised until the go-live date.

Peel Hunt's James Lockyer, another of those in attendance, explained the impact of this: "Hence, where previously the company had described these deals as being earnings neutral, they no longer will be. The costs associated with setting them up will still be recognised when occurred but the revenue that would have been recognised to offset these costs won’t be."

As a result, Ocado's revenue for 2018 and earnings before interest, tax, depreciation and amortisation will be roughly £12-15m lower than previously expected and 2019 revenue and EBITDA will be circa £40m lower.

Versus current consensus forecasts, this is a cut of around 0.8% for revenues and 17.8% for EBITDA for 2018 and 2.2% and 37.4% for 2019.

"Whilst this is a headline cut to earnings, there will be no impact on cash, moreover whilst this cut mechanically makes the business look more expensive, the long-run value of the deals is unchanged," Lockyer said, noting, there is no impact to the existing Ocado.com UK retail business.

Bernstein agreed that the "optics of profit reporting due to IFRS 15 will look ugly" and that the hefty cut in EBITDA numbers "may scare investors as some people (including us) value it on an EBITDA multiple".