Ocado – Blowing Smoke
All,
Please find our marginally changed analysis here.
The return of Revenue growth in the M&S JV has been welcomed by the market. However, Ocado is much more than the M&S JV. The likelihood is that M&S will take control in 2024 and it will be deconsolidated. We also expect that M&S would rather take the whole business in-house. The relationship with M&S is difficult, but the joint control structure was always a temporary fix. Also, the issues for the JV are centred on marketing rather than operations, so the read-across to other potential customers for Ocado’s services is limited. Ocado does need to keep signing new customers. One supermarket has signed up since COVID-19 (Lotte in South Korea). There have been teething troubles in Australia, but these have been customer rather than equipment-related. Ocado needs to avoid another fire like Erith last year caused by a crash between robots.
Investment Considerations:
- The 2025 SUNs currently yield 8% with the 26 and 27 SUNs yielding 12% and 11% respectively. The lower yield for the 27s is down to their convertibility. The 25s are expensive. Until the Retail business is deconsolidated, the 25s will be volatile beyond the actual risk in the Retail business. The 26 and 27s look better value, however, we see this is close to equity risk and inside 12% we are not tempted, considering said volatility and the back-dated economics. The lowest cash price is the 27s at around 73c/€, however, the coupon on this convertible is 0.75% and we see little chance of an early call.
- We recognise of course that over the last year the 27s for instance have risen from around 60p/£ to 73p/£. In hindsight of course we should have bought it then.
- The 50% of the retail JV is worth about £560m to Ocado. If we add today’s option value of the logistics business (based on our terminal value of £5.2bn (per DCF)), we have a value of around £1bn which equates to around 69p/£. The fact is that this will shuffle along for some time before cost and value become clearer and we won't de-risk along the way. But there is also still a monster equity cushion behind us. we will revisit our valuation after the full-year results. With the FYE23 results, we will have a better view of the fee/EBITDA generation of the existing logistics assets.
- Surprisingly, Ocado broke even in H1 (from an EBITDA perspective) profitability will continue to rise in the 2nd half of FY22/23. The Retail business is forecast to generate positive EBITDA. We expect Logistics to approach EBITDA breakeven so overall we expect EBITDA will be positive.
- Revenue in the second half will continue on a positive trajectory. Most visible will be in the Retail business, but we expect progress in the Logistics business as capacity payments start to accelerate.
- The Q3 Trading statement for the retail business, shows H2 as being stronger, as expected by management. Guidance wasn’t changed, but management did confirm that the expected revenue trajectory was being met.
Technology business starting to generate EBITDA:
- We were pleasantly surprised by the positive EBITDA in the business in H1. Capacity payments are rising ahead of our expectations and we will review our model when the FYE23 numbers are published in Q124.
- Signing Lotte in South Korea as a new Technology customer has proved the Ocado concept still has legs. The slowdown in online growth after the turbocharged COVID period has raised some fears among investors. However, the megatrends support the company and it is substantially funded through FCF break even.
- By 2024 our estimates are for EBITDA from Technology to top £250m.
- The project is not without risk. The first Customer Fulfilment Centre in Australia is over budget and behind time. Specification changes by Coles are behind the issues, but a souring relationship with clients could damage further sales. We will keep our eyes closely on developments.
M&S JV, smoke without much fire:
- M&S has publicly criticised Ocado for marketing and product selection rather than logistics failures.
- Some of this is price negotiation as M&S has an earn-out payment of up to £156m in 2024 (the payment is at £138m in the books of Ocado).
- Our analysis points to a deconsolidation) but not a sale in 2024.
I look forward to discussing this with you all
Aengus
T: +44 203 744 7055