• Brett Schafer

Ocado Group: Not So Deep Dive

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Show Notes

(Ryan) What they do: Ocado Group is a robotics/logistics company primarily focused on online grocery. So they have 10 or are expecting to have 10 customer fulfilment centers live and operating by the end of 2021. The size of the CFC’s range, but the large ones look like massive warehouses. And inside they have battery powered robots that run on a grid system. These robots are collecting orders and controlled by an air traffic control system to avoid running into each other. Now the robots aren’t running an entire end-to-end system. They are bringing crates of grocery products to what Ocado calls “pick stations”. Then robots or humans assemble the order.

But as far as where those orders are coming from, Ocado has a few solutions. So it has a direct consumer grocery retail business. If you’re in certain areas you can go to Ocado.com, grab a few groceries you might want and have them delivered to you. Now it isn’t always perfect. They say they have 95% on time delivery and 99% basket accuracy. So this retail portion of the business makes up the bulk of revenue. Some of it is private label stuff, the rest is from suppliers and they take these orders, pick, sort, and deliver to customers.

The other part of their business includes licensing access of their technology to other retailers. This is called Ocado Solutions and it’s supposed to be the most promising element of the business. So far they have signed on 9 partners. These partners include Kroger, Sobey’s, Groupe Casino, and a bunch of international grocery chains. They collect revenue from this segment through invoicing fees for the use of their tech.

(Ryan) History: The company was started in 2000 by three ex-Goldman bankers. CEO Tim Steiner was a former bond trader. It originally started by a branding and sourcing agreement with Waitrose which was a big supermarket chain in the UK. A year later they began their delivery services. Over the 10 years following that, Ocado expanded delivery capabilities, built out their first CFC and listed on the London Stock Exchange in 2010. And they even launched their “own-label” products in 2010 as well.

Since that time they’ve had several capital raises. Built out more CFC’s. Then began signing commercial partners. In the last few years, they’ve really ramped things up. Launched a 50:50 new venture with Marks & Spencer which is a multinational apparel retailer. They’ve signed on several new partners to their OSP. They launched Ocado Zoom which is their one hour delivery service in parts of London.

(Brett) Industry/Landscape/Competition:

  1. Global grocery/food industry over $10 trillion

  2. Over the next decade grocery delivery is supposed to make up a larger portion of that, some estimates as high as 20%

  3. Competitors for Ocado Retail (in U.K.): Whole Foods, Abel & Cole, Just Eat (?), Tesco, Amazon Fresh, Morrisons.

  4. For OSP, they are competing with grocers doing stuff in-house for the most part. It probably took a lot of convincing to sign-up Kroger.

  5. Competitors on OSP side: Mclane FoodServices, Cranswick, a lot of smaller players. Essentially, anyone that is spending money to help grocers (including the grocers themselves) get products to customers is competing with Ocado. Ocado is trying to disrupt this with its high tech offerings

(Ian) Management and Ownership:

  1. Tim Steiner is the CEO and a co-founder

  2. Stephen Daintith is the CFO, recently hired in 2021

  3. Formerly at Rolls Royce

  4. Former CFO is still on the board of Ocado subsidiaries

  5. Tim is a former Goldman Sachs bond trader and has been awarded an OBE (Order of the British Empire)

  6. Last remaining founder (one left in 2010 and is being sued by the company)

  7. Another left in 2014

  8. He was the UKs highest paid CEO in 2019 due to an approximate $70mm one time bonus

  9. Tim owns about 3% of the company

  10. Kroger owns around 6% of the company

(Brett) Valuation:

  1. Market cap of $18.2 billion, ticker OCDO in U.K. (OCCDY on OTC in the U.S.)

  2. Trailing P/S of 5

  3. Trailing P/GP of 13.65 (although I think there are some distribution costs that should be in COR that are not)

  4. For example, in 2020 distribution costs were $900 million, but not included in COR

  5. Shares outstanding headwinds

(Ryan) Earnings:

  1. In H1 2021, total revenue was $1.55B, up 21% YoY

  2. 93% of that revenue comes from its retail business

  3. The EBITDA margin on its retail business is about 8.5%

  4. And they’re using some of that cash to fund the other revenue drivers like OSP and international solutions

  5. They report gross margins at about 41%, but distribution and administrative costs make up another 36% of revenue.

  6. Now the OSP financials are reported weird because Ocado collects revenue in the form of recharges to its grocery partners. But that’s really not providing any profit.

  7. The actual fee revenue or total fees for the first half of the year was $86M, up 31% YoY

  8. This portion had 41% EBITDA margins on it

(Ian) Balance sheet and liquidity:

  1. Cash of almost $2.3B

  2. Raising a lot of capital in the last couple of years

  3. Raised over $1B in the last year

  4. Both stock and convertible notes

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Anecdotal Evidence:

  1. (Ryan) Don’t really have any. I’ve never really been a fan of online grocery but obviously some people are. The videos on YouTube of their fulfilment centers were pretty cool.

  2. (Brett) Online review: “since the Marks and Spencer deal the standards have fallen quite dramatically.” This wasn’t the only one. Also looks like they go through the same problems as all grocery delivery companies (bad quality, about to expire, missed/wrong items)

  3. (Ian) Online grocery, whether pick up or delivery is so nice. Probably will do this going forward.

Future growth opportunities:

  1. (Ryan) I’m torn here. Because part of me wants to say long-term they need to enter new verticals, but short-term it seems like they could still improve on grocery. 95% on-time delivery is fine but that also means they can improve on that last 5%. I imagine it only takes one wrong order to churn a customer. Not sure how they solve that, but optimization on that front is really the entire Ocado CVP.

  2. (Brett) International Solutions. These are the partnerships and CFCs with Kroger and other grocers around the globe. Seeing rapid revenue growth and have over 50 CFCs contracted to be built, so big pipeline here. I would be interested to see what the unit economics of these look like.

  3. (Ian)

Highlights and lowlights:

  1. (Ryan) Highlights: Barriers to entry for a business like this. It’s a tough logistics problem, it’s a capital intensive model, but much of the most difficult elements are behind them. And if you believe that international and OSP are going to be a substantial part of revenue, the ability for them to raise the recent convertibles is going to be critical to that evolution. Lowlights: I’m not a huge fan of the horizontal approach yet. It doesn’t quite seem like they’ve completely mastered grocery.

  2. (Brett) Highlights: I think they have strong customer lock-in, I like the 3rd-party solutions if they can get to solid unit economics and provide enough value to the partners. Lowlights: This business is going to require billions in R&D and capex, and I’m not sure what the return on that spend will be. Ocado Retail is not a business I want to pay up for (the Instacart equivalent). It feels like the “Other Bets” are scattering their focus.

  3. (Ian) Highlights: Makes sense. Fulfillment platform seems to be a needed service. Lucrative contracts. The more contracts they sign with major players, the more their advantage increases, both in prestige and in switching costs. Lowlights: Competition, many rapid delivery partners, yet to be determined how competitive the platform piece will be. I know it’s lazy, but Amazon? Working to patent technology. Not my favorite to see a business sees patents as essential.

Bull case:

  1. (Ryan) OSP has to be a significant portion of revenue. Right now this is a premium valuation if you’re just treating it like a retailer. But if OSP fee revenues reaches $1B this could look like a really solid investment.

  2. (Brett) Kroger, Aeon, and Coles contracts go well, leading to more adoption from other grocers. I don’t think valuation would be a concern if you’re confident this can happen.

  3. (Ian) First mover advantages lead to OSP becoming the platform. They are able to provide enough value that grocery chains around the world choose to use them rather than in-house solutions.

Bear case:

  1. (Ryan) Spread too thin trying to attack multiple verticals. Leads to a decline in quality of their core business and we start to see customers churn. Right now that core retail business is buying Ocado time and runway.

  2. (Brett) This is a delivery company masquerading as a high-tech business. What if all this high-tech stuff doesn’t matter in the end? That would be my bear case.

(Ian) Grocery already has low margins. My bear case is that Ocado has trouble carving out enough value-add to become widely used and even though it is a platform, the margins are never very good, there is consolidation in the grocery industry and all major players do fulfillment in-house.

Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Looking for stocks that have the potential to go up 10x over 10 years? Check-out Potential Multibaggers on Seeking Alpha or on Twitter @FromValue

Disclosure: The authors and podcast guests are not financial advisors. Brett Schafer and Ryan Henderson are portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this podcast.

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