Ocado incurs the City's wrath as investment in distribution hits profits

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Ocado, the online grocer, lost more than 10 per cent of its market capitalisation yesterday after it warned of lower profit margins and its quarterly sales growth slowed.

Ocado, which delivers Waitrose groceries, also continued to suffer from capacity constraints in its third quarter, as its huge distribution warehouse in Hatfield, Hertfordshire, struggles to keep up with strong demand.

But Andrew Bracey, Ocado's finance director, said it had already addressed some of these constraints by installing new equipment and "most will be alleviated" by the end of its fourth quarter.

Ocado's full-year underlying profit margin will be lower after it invested in technology and staff to improve its picking accuracy and delivery times in the third quarter. The improved customer service resulted in items delivered as ordered increasing to 99 per cent and on time, or early, deliveries rising to 95.5 per cent.

But Ocado, which floated at 180p in July 2010, said: "This investment is likely to lead to a slightly lower-than-expected increase in full-year margins."

As a result, City analysts, such as those at JP Morgan Cazenove, cut their underlying profit forecast by £2m to £34m, compared with actual profits of £18m in 2009-10. Despite this, the company is still expected to make its maiden pre-tax profit this year.

Ocado's share price dived by 15.3p, or 11 per cent, to 118.4p yesterday. But Mr Bracey pointed out that the online grocer's shares had risen strongly in recent trading and "they have given up some of the gains they made last week".

Ocado, which was founded in 2000 by three former Goldman Sachs bankers, lifted sales by 16.9 per cent to £147.9m in the 12 weeks to 7 August. But this was down from growth of 18 per cent in its second quarter and a surge of 24.8 per cent in the first quarter of this financial year.

Jonathan Pritchard, an analyst at Oriel Securities, said: "We believe that the business model here is coming under increasing pressure, as delivery charges fall and competition rises."

Mr Bracey said consumers were shopping more frequently with Ocado, partly driven by the tough economic conditions. This has led to the Ocado Delivery Pass – which provides free delivery to customers who pay a monthly or annual fee – accounting for more than half of all orders placed.

This largely contributed to the average order size at Ocado falling to £111.08 over the 12 weeks, compared with £113.59 last year.

Once Ocado has added new capacity at its warehouse in Hatfield, it will be able to deliver about 140,000 orders a week in this quarter. This compares with average weekly orders of 110,945 in its third quarter.

The online grocer is also trying to entice new customers with a price initiative on more than 500 branded products, although this will be gradually rolled out to existing customers over the coming months.

Customers who pay £8.99 a year for the Total Saving Pass get at least 10 per cent off the price of 580 items, such as Ariel washing powder and Pampers nappies. Ocado claims this could save regular shoppers more than £100 a year.

Mr Bracey said: "The key things that resonate with customers are price, range and on-time delivery, and we are increasingly focusing on these over the next 12 months."