From transformation to possible takeover, what’s going on at Ocado?

The last couple of weeks has been quite the rollercoaster ride for online grocer Ocado.

Its previously plummeting share price soared more than 40% – and then fell back again – as rumours of an Amazon takeover swirled.

Meanwhile, the grocery side of the business has been pushing ahead with its turnaround plan as it cut prices and pressed the button on a high-profile TV advertising campaign.

The pressure is on to get results as Ocado Retail joint venture partner M&S chair Archie Norman told its shareholders it was “not happy” with the online grocer’s performance as CEO Stuart Machin flagged a string of errors, from poor availability to missed opportunities to promote M&S products.

However, today the online firm unvelived a £289.5m half-year pre-tax loss. Grocery Gazette takes a look at what’s going on at Ocado, and how it plans to turn around the business.

The wavering fortunes of Ocado

Ocado has had a turbulent last couple of years, to say the least.

Its retail business, which is half-owned by M&S, saw a boom in consumer demand during the pandemic as its share price hit a record 2,895p in September 2020.

However, since then its value has plummeted almost 80% as shoppers have abandoned online and head back to stores since Covid restrictions have eased.

On top of this, the group reported an eye-watering pre-tax loss of £501 million in its last financial year, which Shore Capital analyst Clive Black termed a “truly dismal performance”.

This was followed up this morning with a £289.5m half-year loss – although the business did get back into the black on an EBITDA level.

So, what has led to this decline?

Ocado is a business with two distinct sides. It’s online grocery business, which it runs alongside M&S, and its solutions business, which provides automated technology to 12 grocery partners around the world, including US-based Kroger, Australian supermarket Coles and French grocer Casino.

Despite what is seen as the huge growth potential of its solutions business, its £2.2bn Ocado.com sales  last year eclipse the £802m made from its UK solutions and logistics clients and the £147m made via international partners,

Today the retailer revealed it had made a small EBITDA profit at the solutions and logistics side of its business in the six months to 28 May, but Ocado Retail still remained in the red.

Both sides of the business, however, have their own set of challenges right now.

On the grocery side, Kantar senior manager of global retailer insights content Howard Lake says the fact that Ocado “is seen, rightly or wrongly, as overly expensive” means it is failing to reach enough households to scale effectively.

On the solutions side, Ocado has suffered from waning analyst sentiment.

Despite a flurry of activity signing up international partners a few years, Black notes there has been “limited additional good news about Ocado being the technology of choice for supermarkets around the world”.

He also notes there has been “somewhat pedestrian progress” in one of its key contracts, the USA’s second largest supermarket Kroger.

Interactive Investor head of markets Richard Hunter told Proactive Investors earlier this year: “The promises of large-scale adoption for its cutting-edge technology has yet to fully materialise after some considerable time, which has led to investors shunning the stock in their droves.”

Takeover talk

Ocado’s dwindling share price has inevitably led to rumours of a takeover. The sudden rally on shares late last month was spurred by speculation that Amazon could make an 800p-a-share takeover bid for the retailer.

While Amazon has not commented on the rumours, it’s easy to see why Ocado may be a good fit for the online giant.

Amazon has struggled to gain traction with its own grocery business, Amazon Fresh, and is already selling tech solutions, such as cloud computing, to retailers.

But are there any truth in the rumours? Some industry-watchers are doubtful.

GlobalData lead retail analyst Nick Gladding says: “An Ocado-Amazon tie-up has been talked about for years. If Amazon had wanted to buy Ocado, it would have acted before now.”

JP Morgan analysts Marcus Diebel and Karin So say that while Amazon “would have the financial capabilities for a potential acquisition and coverage of Ocado’s debt liabilities,” it questions how relationships with current partners such as Kroger – a potential competitor to Amazon Fresh – would play out.

Ocado Retail’s transformational ‘reset’

Takeover talk aside, Ocado has been pushing ahead with turning around is ailing UK grocery business.

Last year, the division suffered a £4m EBITDA loss last year and a sales fall of 3.8%.

The grocer blamed “a challenging market” as it saw the unwinding of the Covid-driven online surge, along with the cost-of-living crisis taking its toll.

Retail Technology Magazine publisher, author and consultant Miya Knights says that Ocado was always going to be hit by a drop in online demand, as although the supermarket “grew quite considerably during the pandemic, consumers have proven themselves to be more likely to want to return to stores”.

Partner M&S made a £29.5m loss from the joint venture over the past year and chairman Archie Norman told investors at the its AGM last week that he was “not happy” with the online supermarkets performance.

“Joint ventures are hard but also online food is hard, so we’ve got work to do,” he said.

The retailer has set about this task with a “customer driven” reset plan led by new Ocado Retail CEO Hannah Gibson, a tech specialist that was already working at the online firm .

Gibson took up the post in September last year and  will be supported by Tesco grocery category director, Amit Chitnis, who was hired as its new chief commercial officer last month.

The reset plan aims to looks to improve the availability, quality and life of each product on the site, and increase the M&S product offer on its site.

Availability is most definitely an issue at Ocado. Machin told shareholders that three quarters of M&S products were recently unavailable to buy on Ocado’s warehouse.

He also vented his frustration at Ocado’s failure to feature M&S branding in adverts or emails.

Machin is confident that by working together more closely, it can bolster sales. He says the “potential is pretty huge” and “despite not much effort, M&S is 26% of the Ocado sales”.

Another major part of its ‘reset’ is to up its value credentials.

Prices of more than 100 everyday branded, Ocado own-label and M&S items were reduced by 25% in late June and earlier this year, the online-grocer launched its new Price Promise, which looks to compare prices against over 10,000 like for like products at Tesco.

Knights says that these schemes are helping Ocado “address any gaps in its value” while Lake expects that it will “see some return” from its efforts to counter negative price perceptions.

Lake adds that Ocado’s challenge is to “grow its basket size”.

Indeed, Ocado’s order numbers jumped 5.6% in its last financial year, and active customer surged 13%. The big problem was the that the average basket value dipped 8.5%.

Black says: “Ocado Retail must seek to eke out each order, delivery route, and so forth and seek to improve the operating ratios in forthcoming years, and we are talking years before a substantially more profitable business can emerge.”

To help grow basket size, Ocado has also launched a new advertising campaign earlier this month to showcase that it has “more choice than any other supermarkets”.

The grocer has already seen some green shoots as sales grew 5% over its latest half year.

Ultimately, partner M&S has faith that Ocado Retail will continue to grow.

“There’s a lot to do but medium to long term, I think we’ll be looking back and saying this is a great online business for M&S,” says Machin.

What’s next for Ocado?

The grocery turnaround may be in full swing but Lake says longer term Ocado’s “biggest issue in the UK” is scaling up operations.

“M&S is frustrated by Ocado’s inability to reach more households, so investment in more CFCs is needed for wider reach.”

Although a takeover might not be on the cards, Lake does think the business could benefit from being broken up.

He describes the solutions business as the “long-term revenue engine for Ocado” and says there may be a case to let the UK grocery delivery business go.

“The contribution of the retail arm to overall group revenue as a percentage will likely decline over time and Ocado management may not want to rely on retail income as part of its future strategy,” he says.

It has long been speculated that M&S will buy the remaining 50% of the retail business that is currently owned by Ocado.

Lake says that it could be a sensible move in the long term as it would allow M&S to “scale the business on its own terms”.

However, he questions whether it “would want to disrupt what has been, thus far, a pretty well-executed turnaround plan” at M&S.

Could M&S buy the rest of Ocado Retail?

Gladding points out that M&S’ recent trading strength puts it in a stronger position to finance a buyout, although he concedes it may make more sense “not to be distracted from existing investment priorities”.

Knights suggests the next move for Ocado’s Solutions business should be to “increase the rollout of its warehouses and accelerate the partnerships that it has”.

However, that does not seem to be the plan in the UK. In December, Ocado announced that its new CFCs, scheduled to open in 2024 and 2025, would be delayed.

CFO Stephen Daintith said this was a “sensible” move as the grocer was experiencing a decline in demand.

It’s a different story overseas however, where it has committed to build over 60 CFCs for its partners, and just last week launched its first robotic warehouse in Asia with Japanese supermarket partner Aeon.

Although today’s update, particularly breaking into profit on an EBITDA level, may have eased pressure slightly, there are still questions being asked about its longer term prospects.

Rapleys head of retail Richard Curry says: “You cannot have a company valued at the level Ocado is – shooting up the FTSE – whilst not declaring a profit. It doesn’t make good financial sense.”

Black is dubious about whether the business will ever achieve sustainable profitability.

“One day in a distant time zone the Ocado Group may be surrounded by the words, meaningful sequential pre-tax profits, who knows, it may even pay corporation tax, but one cannot yet see the rainbow, never mind any pot of gold,” he says.

Black describes the business as a place that has lots of research and innovations but “simply is incapable of making any form of positive economic contribution”.

“The sense that all this innovation is so good that the financial output is irrelevant captured stock markets and technobabble merchants for many years but at the end of the day this is an organisation that purports to be a business with an equity attached where financial performance matters – it is not a privately funded research house.”

With confidence wavering, a lot is riding on Ocado’s shoulders. It has built both the technology and offer that has set the bar in online grocery, but has yet to prove itself as a sustainable, profitable business.