Ocado sets sights on summer flotation after sales rocket

Online retailer is yet to record an operating profit, but could expand in £1bn offering, reports James Thompson
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The Independent Online

Ocado, the online grocer, has in effect fired the starting gun for what could be one of the most audacious flotations of the past decade this summer by posting a surge in 2009 sales.

The company, which was set up by three former Goldman Sachs bankers in 2000, also revealed yesterday that it had cut its operating losses by a third to £14.4m last year.

Ahead of a potential float that could come as early as July, Ocado unveiled two new non-executive directors – David Grigson, the former financial chief at Reuters, and Ruth Anderson, the former vice-chariman of KPMG – to strengthen its board.

But there are potential obstacles in the way of a mooted £1bn initial public offering. Above all, concerns have been raised about the fact that Ocado has never made an operating profit. Another major concern is that Ocado has a five-year contract with Waitrose but there is no guarantee it will be extended after 2013. Furthermore, Waitrose is itself gradually expanding its own online delivery into Ocado's heartland inside the M25, although there has been no change to the terms of the 2008 agreement – which contained undisclosed non-compete clauses.

But Andrew Bracey, the finance director of Ocado, remains bullish about the prospects for the group. "I think we will not see anything this side of the election, but the business is in good shape and we are seeing an acceleration in sales. We have said we would like to float the business at some point and we hope this will be later this year."

Certainly, Ocado's multi-temperature, automated depot – which covers the size of 10 international football pitches – in Hatfield, Hertfordshire, is impressive. It has a 9-mile network of conveyor belts and huge levers that speed grocery baskets to their destination, which enables 12 to 15 individual items to be picked per second.

Most of the financial data is heading in the right direction too. For the year to 29 November 2009, Ocado delivered total sales up 25 per cent to £427.3m. Its sales, on a like-for-like basis, jumped by 30 per cent for the 12 weeks since the year end – up from 22 per cent in 2009.

Andrew Kasoulis, an analyst at Credit Suisse, said: "Ocado's like-for-like sales have gone up at a time when the wider grocery market has slowed." Ocado did not provide a pre-tax profit figure, but instead pointed to a 321 per cent surge in earnings before interest, tax, depreciation and amortisation to £9.2m, compared with £2.2m in its 2008 financial year.

Ocado's model and float potential divides opinion in the City, but Mr Kasoulis said: "When retail businesses achieve strong sales a lot of the rest looks after itself. If they get the cost structure right and the sales growth continues then you get to a point where they will get some operating profit leverage."

Market sources also make comparisons between Ocado and Amazon, which did not make a pre-tax profit for several years after floating in 1997. For the year to 30 November 2008, Ocado made a pre-tax loss of £32.7m, according to accounts filed at Companies House. But one market observer said that comparisons with Amazon are wide of the mark, given that one delivers multi-temperature fresh and ambient food, while the other specialises in books and CDS.

Among the sceptics, one of their biggest concerns is how Ocado has never made an operating profit. A key issue is its heavy reliance on its computer systems, including software developed in house, which means it incurs sizeable annual depreciation costs in its supply chain. This figure is also subject to software upgrades and redevelopment every two to five years.

Ocado suffered a £23m depreciation charge on tangible assets, including IT, equal to more than 6 per cent of total sales of £338.5m in 2008, according to Companies House. For rivals, such as the market leader Tesco, this annual depreciation charge is around 2.5 per cent for their online grocery model.

There is also the issue of Ocado being up against Tesco – whose market share dwarfs rivals – as well as Sainsbury's and Asda. The big three grocers all operate a "pick in store" model but Tesco currently has two so-called "dot.com-only stores", which have no customers and are dedicated to web sales, while Asda has one.

In contrast, Ocado's central depot in Hatfield serves five regional spokes around the country. Mr Bracey said: "Our pick model is two to three times quicker than conventional stores or the dark store [ie dot.com only] model."

But some analysts are sceptical about the model, particularly when customers are choosing their delivery slots. Greg Lawless, the analyst at Collins Stewart, said: "Picked in Hatfield and delivered to Leeds. It is difficult to see how it makes money. All the costs are in the last mile."

Furthermore, a decent chunk of the more than £300m Ocado could raise from a flotation is also likely to be invested in a second major depot – north of Birmingham – which is likely to cost an estimated £100m to build.

In fact, Mr Bracey correctly points out that Ocado – which currently does not deliver north of Harrogate, Yorkshire – has plenty of room to grow. He said: "We only cover about 65 per cent of the country by postcode. There is significant growth to come from just expanding our geographical footprint."

Up to 40 per cent of the UK population could order their food for direct delivery over the internet by 2025, according to retail analysts OC&C Strategy Consultants. Mr Bracey also dismisses any concerns about Waitrose eating into its market share with their own online delivery by saying: "Where we and Waitrose operate together we both grow faster. We are basically advertising both brands."

Furthermore, the potential of Ocado may not be limited to these shores. While Mr Bracey declined to name names, it has held talks with overseas retailers concerning a joint venture to replicate its model in other countries. Grocers such as the French giant Carrefour are thought to have held talks with the UK online specialist last year. But Ocado's potential float is likely to divide opinion until it actually happens. After that, the focus will again turn to its first pre-tax profit, but retail watchers and investors may have to wait longer for that day.