If revenue is vanity and profit sanity, then backing Ocado — and its consistent pre-tax losses — requires an investor to take leave of their senses. Yet that’s not stopped the online grocer attaining a position in the FTSE 100.
The retail joint venture with Marks & Spencer is Ocado’s shiny shop front, proof of its model in full swing. That business did well out of lockdown, revenue grew by just over a third last year thanks to an rise in average basket size and active customer numbers, but the lifting of restrictions and greater competition for customers’ cash means that the exceptional level of demand has started to fall back. And that was even before a fire at its fulfilment centre in Erith, southeast London. The fire is expected to cost £10 million this year and the centre won’t get back to full capacity until November.
The group’s enterprise value stands at five times forecast sales for 2021, or an eye-watering 159 times earnings before interest, tax and other charges. Operational mis- steps aside, a racy valuation also leaves the shares vulnerable to being caught up in a further sell-off of racy growth stocks as ultra-loose monetary policy in the United States is wound down.
While its retail joint venture accounts for the bulk of revenue, despite Ocado being entitled to only 50 per cent of income, the British and international solutions and logistics businesses, which provide software and automation for grocery delivery, are the drivers of the group’s value. These, though, are cash-guzzlers. The construction of warehouse buildings is funded by clients, but the cost of the software and automation technology is borne primarily by Ocado. The solutions business charges clients an upfront fee and a continuing fee based upon delivered sales capacity, which analysts estimate are roughly 3 per cent and 5 per cent, respectively. The group might have inked deals with numerous retailers, the latest being the Alcampo supermarket chain in Spain, but the delay in that income being received means that revenue for the solutions business is dwarfed by the huge costs associated with building that capacity.
Amid the pandemic surge in online grocery shopping last year, revenue growth at a group level outpaced the rise in administrative and distribution costs. However, that was an anomaly when compared with recent years and Ocado still reported a pre-tax loss of £149 million for 2020. That record was repeated over the first half of this year, in the form of a £23.6 million loss. Investors shouldn’t expect a pre-tax profit any time soon. Analysts have forecast another loss of £143 million this year, widening to £153 million in 2022. You get the idea.
At present, Ocado has six customer fulfilment centres live in the UK, with another soon to open in Bicester, Oxfordshire, and four centres in international markets including America, France and Canada. Not all of those are at full capacity yet and its committed pipeline stands at a much larger fifty-six, across eight markets beyond 2022.
Ocado had £1.7 billion in cash resources at its disposal at the end of May and management apparently has no plans to raise equity, but ultimately capital requirements depend on the pace at which customers require new capacity.
Missing capacity targets, more fires or additional costs associated with trying to stop similar events happening again could cause the shares to falter. That’s without mentioning the impacts of supply chain and wages inflation. It won’t take much to break the spell.
ADVICE Avoid
WHY High valuation leaves it overly exposed to capacity misses and does not seem justified given there is no sign of a statutory profit
Home Reit
Putting high dividends and impact investment at the front of your pitch to investors is an obvious move, but nonetheless one that both retail share-buyers and institutions are likely to bite on. On the same day that the float of the BMO-managed Responsible Housing Reit was unveiled, Home Reit announced plans to raise £262 million from investors less than 12 months after floating its shares.
Both have pledged attractive dividends from letting social housing. Home Reit focuses on putting a roof over the heads of homeless people, with a portfolio that spans England. It plans to use the proceeds of its capital-raising, launched at the end of last month with retail investors able to participate, to help to fund the acquisition of a pipeline of properties valued at about £400 million.
At present the real estate investment trust has no plans to forward-fund developments, bar two potential sites in Manchester. Instead, it acquires small apartment blocks or houses from sources ranging from buy-to-let landlords to student accommodation operators. It refurbishes the properties and signs leases with charities, community interest companies and housing associations, ultimately funded by support from local and central government.
A reliance on public finances does not mean the business is without risk, but its maiden interim performance was encouraging. Rent collection was 100 per cent of that due and the average rent payable by the charity is about 45 per cent of the total housing benefit received per property, equating to rent cover of 2.25 times for the tenant base. That income stream should translate into some liberal dividends. The Reit is on track to pay 2.3p a share in its maiden year and in 2022 it targets 5.5p. At the present price of 111p, that would leave its shares offering a potential yield of almost 5 per cent a year. There is also a degree of inflation linkage as leases increase in line with consumer prices inflation, capped at 4 per cent a year.
The shares are up by about 12 per cent on the initial listing, translating to a 7 per cent premium to the Reit’s July net asset value. Income potential and rising values of the underlying assets could cause even more buzz.
ADVICE Buy
WHY High-dividend yield is backed by long leases and rising property values
