UK Edition
Ocado has proved to be an investment of “two halves” since this column determined it was a “risky buy” on March 8 2020. In the first 11 months following our tip, shares in the digital grocery business generated a capital gain of around 150pc as the pandemic raised investor appetite for online-focused stocks and forced many consumers to shift their spending towards digital avenues.
Since then, however, its share price has collapsed by over 50pc since February 2021 so that it now trades just 15pc higher than at the time of our original advice. During that time, investors have increasingly prioritised value stocks over growth shares. Furthermore, investor demand for online-focused firms has moderated as Covid-19 lockdown measures have abated. This has harmed sentiment towards the firm at a time when its profitability has also deteriorated.
Indeed, last week’s full-year results showed that Ocado’s pre-tax losses more than trebled versus the prior year. Higher investment and rising labour costs were major contributors to the firm’s worsening financial performance. While they may persist in the near-term, and could be detrimental to profitability in the current financial year, Questor believes that the long-term growth outlook for the firm remains intact.
Notably, consumers are increasingly shifting grocery spending to online channels. Currently, 12pc of groceries are purchased via digital channels in the UK. By 2025, that figure is expected to reach 18pc. This provides a clear growth opportunity for the firm’s 50:50 UK joint venture with Marks & Spencer, which has generated 42pc sales growth over the past two years.
Similar growth opportunities exist in other developed economies, such as the US, Japan and across Europe, where Ocado has signed partnership agreements with established retailers to provide technology that allows them to sell groceries online. In the US, for instance, online grocery sales as a proportion of total grocery spending increased by two percentage points in 2021. Digital sales now account for 13pc of the total market and are widely expected to grow in popularity as their availability becomes more widespread.
Ocado expects to almost double the number of operational customer fulfilment centres (CFCs), which are essentially advanced warehouses, across its broad range of geographical locations in the 2022 financial year.
This will further diversify the business away from its UK retail operations and, as a larger number of CFCs become operational, the firm could benefit from increasing scale and operating leverage that acts as a catalyst on profitability over the long-run.
Meanwhile, the company’s ongoing innovation could strengthen its market position through improving efficiency relative to peers. For example, changes to the design of CFCs built from 2023, and which can be retrofitted to older CFCs, mean that direct labour costs will be around 30pc lower compared to their predecessors. This could be attractive given the prospects for rising wage costs in a period of higher inflation and current labour shortages.
Encouragingly, the company’s cash .position of £1.5bn suggests it has further scope to invest in new technology to further reduce costs and improve its competitive advantage.
It also has the financial means to make further acquisitions following recent activity that could provide growth opportunities in adjacent markets within the robotics and artificial intelligence arena.
Indeed, our original advice to purchase Ocado was based on the company’s long-term potential. We did not anticipate a surge in its share price over a matter of months at the time of our original tip. After all, the pandemic had not yet prompted lockdowns that ultimately catalysed demand growth for online grocery deliveries.
Clearly, the company’s worsening bottom line and recent share price fall are disappointing. However, with the firm’s shares now trading on a price-to-sales ratio of 3.74, versus 4.6 in March 2020, and its growth opportunities arguably stronger in a post-pandemic world that has accelerated online trends, we remain optimistic about its long-term share price prospects.
Questor says: hold
Ticker: OCDO
Share price at close: £12.94
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