Ocado-delivering to order

Posted by Liz Rees in Latest insights category on 15 Mar 19

Ocado is a UK based technology company, set up to take advantage of the huge potential for home delivery of food. The brainwave of three investment bankers, it is now a fully operational business with significant revenues.

Having mentioned Ocado in a recent review of the food industry, I thought I would delve a little further into the growth attributes of this relatively new constituent of the FTSE 100 index.

A market there for the taking

Online is forecast to be the fastest growing segment of the food market, increasing from £11bn in 2018, only 7% of total grocery spending, to £17bn by 2023 (Institute of Grocery Distribution estimates).

Ocado recognised the ‘significant market opportunity’ and while rival supermarket chains fulfilled internet orders from local stores, it pioneered a centralised business model based around a hi-tech hub in Hatfield, Hertfordshire.

The (short) history of Ocado

Established in 2000 by Tim Steiner, the current CEO, and 2 colleagues from Goldman Sachs, Ocado began trading in partnership with Waitrose in 2002 and listed on the London Stock Exchange in 2010. The founder’s lack of industry experience, and a valuation in excess of £1bn, meant there were many doubters.

A leading analyst on the food retail sector, where shares more commonly trade on modest ratios, will be forever remembered for his research note titled: ‘Ocado starts with an 'o', ends with an 'o' and is worth zero.’ Even former Tesco CEO Sir Terry Leahy described the business as a ‘charity’.

Despite the scepticism, the company’s shares have multiplied six-fold since the IPO. Having touched £11.30 last summer, they currently trade at £10.45 after recovering swiftly from the setback of a fire at its Andover warehouse last month.

Investors keenly stumped up further capital to develop the proprietary software for the fulfilment solution; the company is believed to have raised more money than any other European internet start-up. Although the business achieved sales of £1.6bn in 2018 it still makes significant pre-tax losses.

Nevertheless, Ocado has met its strategic objectives of building a network of state-of-the-art distribution warehouses, adding capacity both in the UK and overseas. As Steiner explained ‘the infrastructure, technology, and software we needed didn’t exist, so we created it.’

With the infrastructure in place, exclusive international partnerships have been signed with leading food chains in the US (Kroger), Sweden (ICA), France (Groupe Casino) and Canada (Sobeys) to deliver groceries within a one-hour window. In the UK, Ocado has begun to fulfil orders for Morrisons.

It’s all about the robots

Ocado Smart Platform (‘OSP’) is the technology which automates order fulfilment. It has registered hundreds of patents and employs over 1,200 professionals in fields including real-time control systems, robotics, vision systems, routing systems, machine learning and data science.

OSP plans and picks orders with robotic arms then uses in-van technology to support drivers with navigation and doorstep delivery. Algorithms track the order from placement to arrival on your doorstep. These can easily identify if anything has been missed or damaged and track employee input. It may sound a bit ‘big brother’ but has vastly improved efficiency with 99% order accuracy and 95% delivery punctuality.

The app, 'Ocado on the Go', enables users to do their grocery shopping without the need of a PC. In 2017, Ocado was the first UK supermarket to launch an app for Amazon’s Alexa voice assistant that allows users to add products to an existing basket via voice command. It is currently trialling driverless cars; eliminating human input could mean customers will one day be opening their door to a robot.

The old embraces the new

Ocado and Marks & Spencer have announced a deal to take the latter’s food division digital. M&S is paying up to £750m for a 50% stake in Ocado’s UK retail business which will be supported by OSP. This will replace Ocado’s relationship with Waitrose.

The platform will offer customers Ocado’s own-brand products alongside the M&S range and will result in the venture becoming one of Ocado Solutions' largest customers.

Ocado CEO Steiner said: ‘This is a transformative moment in the UK retail sector with the combination of two iconic and much-loved retail brands set to provide an unrivalled online grocery offer.’ Perhaps it is no coincidence that Ocado’s chairman is the former CEO of M&S, Stuart Rose.

The outlook for two very different companies

This is an interesting alliance of the old and the new. You may be surprised that the current market capitalisation of Ocado is £7.3bn compared with £4.5bn for M&S which began life in 1884 as a market stall in Leeds.

For Ocado, the deal looks like another step on its march to dominance of the home delivery market. Critics question the pace of rollout but Ocado has a strong USP, market leading partners and an established market position. There will be challengers, but they increasingly have a lot of ground to make up.

The jury is out on M&S which had to launch a rights issue and cut its dividend to fund this venture but could it mark a turnaround in its fortunes? It looks promising but 40% of turnover is still from clothing and home which faces the decline of high street shopping.

Which funds have been riding the wave?

Funds which have their biggest positions in Ocado include Baillie Gifford Global Discovery and Jupiter UK Smaller Companies. It was more difficult to find funds taking a big bet on M&S although it is a top ten holding in Invesco UK Focus.

Shares in growth companies like Ocado and household names such as Marks and Spencer are often popular with private investors and are available on the Willis Owen platform. However, they do carry stock specific risk and should only be held as part of a well-diversified portfolio.

Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.