Massive losses, growing tech spend and an M&S elephant in the room, but Ocado CEO says this is "our time"

Given that he’s CEO of a company that’s just turned in a full year loss of £44.4 million, from a loss of £9.8 million last year, Ocado’s Tim Steiner is on bullish form, bigging up what he calls “our 18-year overnight success”.

His confidence was supported by a corporate presentation that was triumphalist in tone throughout:

The market is at an inflection point - now is our time…we have many opportunities to create future value…the story has only just begun.

So where’s all this rhetoric coming from? Well, firstly sales rose across last year by 12% to hit £1.48 billion, while average orders per week were up 12.1% year-on-year to 296,000. And 2018 also saw Ocado’s online grocery tech adopted by three more international retailers - Sobeys in Canada. Kroger in the US and ICA in Sweden. They join Spain’s Bon Preu and France’s Groupe Casino Monoprix which were secured in 2017 and Morrisons and Waitrose in the UK.

But of course what’s leading to the hefty losses is ongoing investment in the very tech that is finally beginning to attract more third pary retailer adoption after a dry spell - it was four years between the Morrisons and Bon Preu, a long period of ‘jam tomorrow’.

This is a long game and that investment will continue with 2019 CapEx looking to be in the region of £350 million. Technology headcount has grown 76% in three years to hit 1,300 in 2018. The firm has filed 395 patents across 80 separate innovations, up from 73 patents in 2015.

While there won’t be any new automated Customer Fulfilment Centers (CFCs) opening in 2019, there are many to come - the Kroger deal in the US alone will account for 30 new centers. Steiner is unapologetic about the need for ongoing spend:

Our model remains as it was before - it’s around our investment, our investment that allows us to innovate. We innovate to improve the customer proposition, the customer experience.

Steiner argues that as more CFCs are built for customers, so Ocado benefits from reduced cost of ownership and from economies and efficiencies:

During the course of 2019, we’ll introduce live robotic picking into production. We’ll introduce this year our third generation of robot…they have over 75% new components compared to our second generation of robot that we introduced last year. That robot itself had 25% new parts compared to the first generation.

As we make changes to these robots, we’ve significantly increased our testing capabilities. So today when we introduced new software onto the robot, we have performed the equivalent of over a thousand hours of testing for every software release that we do.

Software development is also a priority:

We’ve written a lot of cool software that means we’ll be able to run multiple facilities across the world at the same time and manage them from a single room in Hatfield. Examples of that would be machine learning software that reads the ‘talk’ coming off the wheels of each of the robots and is able to spot any discrepancies, compare them to historical issues and tell us that we’ve got a water spillage in an exact position on the grid. Or an oil spillage - it knows the difference.

We’ve got software now that can use the CCTV camera system to tell us exactly where each bot is. Previously if a bot lost its location, a human would have to manually work out where it was. The single largest cause of any collisions was human error.

Zoom

Ocado is also about to trial a new one hour delivery option called Ocado Zoom. Starting next month in West London, it will be built around “small batch delivery” on around 10,000 items. It’s easy to read this as a response to Amazon's ambitions in the online grocery space, although Steiner isn’t interested in such a view, arguing that Amazon hasn't made a big impact in the UK grocery space ( to which the automatic response has to be, yet!)

The Ocado line is that there is a differentiator between Zoom and other “immediacy offerings” in the market:

It’s a genuine long term sustainable and profitable opportunity. We will sell over 10, 000 [product] lines, a range thats more like an actual Tesco or Sainsbury’s supermarket, not the 1500 items you’d find in one of their convenience stores. And it will have competitive pricing and low delivery fees. We’re able to do this because it is a unique model with micro automated centralised fulfilment being fed itself from our large scale automated centralised fulfilment…part of a complex delivery network operated with clever software that enables us to replenish very cheaply and efficiently in small batches, allowing us to carry a large range in a small site.

Steiner adds:

The key is that we can run the warehousing, the micro-fulfilment center and, most cricically, the supply chain into the micro-fulfliment center for not significantly more than we can run [a] large facility. That’s where we dramaticaly differ from a number of other solutions that people are trying to sell in the market. They’re all focused on that once the goods are in this machine, how quickly they can get them out of the machine. But in the grocery market you’ve got to focus on all the costs, from the supplier all the way through to the customer.

The elephant in the room of course is Marks & Spencer (M&S) after rumors circulated last month of that firm using Ocado to solve its own online grocery problem, the problem being that it doesn’t have an offering and its CEO has dragged his heels about addressing that shortfall.

Such a partnership, in whatever form it took, would potentially appear to create a conflict for Ocado since M&S pitches for the same high-end demographic as Waitrose. Under the current arrangement with Waitrose, Ocado wouldn't be able to add the own labels of another UK grocery retailer into the current Ocado offering.

But crucially the ten year relationship with Waitrose is due to wind down in 2020 with a current September end date. Given that there’s no guarantee that the deal will be renewed - Waitrose has its own online service today - the timing could be very opportune for both M&S and Ocado.

Steiner was inevitably coy on the subject:

We are in the business of talking to retailers, we're constantly talking to retailers around the world. We are not going to deny or confirm...We've been on 18 months rolling notice [with Waitrose] for three or four years. There was quite a lot of speculation that the first day that Waitrose could give notice under the contract, they would. Obviously they never did.

What I can say with great confidence is that today we sell over 50,000  products to our customers. In September 2020, we will still sell over 50,000 products to our customers, including our high quality own label range. Whether that's called Ocado or Waitrose or something else, I can't be 100% sure.

And he did note of the M&S scuttlebutt that:

Rumors about this particular person were out in 2017 as well.

Which isn’t exactly a no…

My take

While the initial rumors of a tie-up boosted the share price of both Ocado and M&S, there’s a risk attached to any protracted period of uncertainty, as Laith Khalaf, Senior Analyst, Hargreaves Lansdown, notes:

Such high expectations baked into the share price raise the possibility of disappointment for investors. In this respect, Ocado is similar to Amazon, which likewise comes with a lofty price tag as the market has pencilled in high levels of future earnings growth. We saw the extreme market reaction to slowing growth from such well-backed companies last December, when ASOS disappointed the market with only 15% sales growth, and subsequently saw its share price almost halve.

Meanwhile Ocado remains committed to a long game and making the investments in the future that it needs to, regardless of the impact on the bottom line. So far, investors are along for the ride.