You have to give it to the management of Ocado for sticking to their guns. Since the online grocer was founded nearly two decades ago, Ocado’s top brass have had to spend almost as much time trying to convince naysayers about the wisdom of the company’s business model as they have actually running the business.
This is because, on the face of it, there are many reasons to be bearish on Ocado. This is a company that claims to be the best online food retailer, not only in the UK but possibly even the world, but has barely made a profit since it started. Ocado only generated its first profit — a modest £7.2 million — in 2015, which then rose to £11.9 million in 2016 before slipping back into the red with a £500,000 loss last year.
Ocado has failed to make any meaningful profits because although it has a fast-growing and profitable business, which supplies groceries online, it has been investing heavily in its international licensing business. Much of Ocado’s heady valuation is based on the management’s stated belief that the company’s true destiny does not lie in shipping more tins of beans and pints of milk for Morrisons or Waitrose, but in licensing its snazzy software technology to international retailers.
According to Ocado, acting as the online delivery partner of choice to retailers globally is where the real growth is. It plans to fulfil this aim by licensing its Ocado smart platform solution — which involves highly specified software and warehouses, known as customer fulfilment centres, filled with giant robots picking products for online deliveries — to as many partners as possible.
It took until last December to sign its first deal. Like buses, the deals all started to come at once and in the past three months Ocado has signed with Groupe Casino, the French retailer and Sobeys, Canada’s second largest food retailer.
This all sounds promising. The slight snag comes from the fact that Ocado won’t make any money on these partnerships for some time. It has to pump in some significant investment up front to get them off the ground and then, in time, as it ramps up its capacity the revenues and profits should flow. Ocado has in the past talked about £30 million of peak capital expenditure per deal — not chump change in other words.
Investors have had to trust Ocado knows what it is talking about. And so far, they appear to, with Ocado raising £144 million to plough into its international business in an oversubscribed fund-raising last month. It should become easier to gauge the success of the licensing arm as Ocado has started to split out the performance — showing sales and earnings before interest, tax, depreciation and amortisation (Ebitda) — of its retail and solutions business. Last year Ocado’ solutions arm had £116 million of revenue and Ebitda of £2.7 million, compared to a retail business with revenue of £1.3 billion and an Ebitda of £79.2 million.
All eyes will be on how the two divisions develop in time. Ocado’s retail business is running well, with first quarter sales jumping nearly 12 per cent to £363 million and it is set to grow further when its fourth and largest fulfilment centre in Erith opens this year. But the real prize is overseas, as grocery is the largest retail market in the world and if Ocado can gain a dominant position it could be set for a bright future.
Ocado’s shares have enjoyed a massive bull run in the past few months, off the back of licensing news, rising from 238.7p a share in November to 568.2p a share yesterday. It may not be a buying opportunity right now, but it is certainly one to watch.
Advice Hold
Why The shares have had a strong run on recent rash of announcements on partnership deals. Wait to see what further progress is made.
Enquest
Enquest is hoping to reduce its debt as a mammoth North Sea project starts to deliver. The first oil began to dribble out of Kraken, some 77 miles east of the Shetland Isles, in June last year but the boost in the oil company’s operations was much slower than had been anticipated.
Enquest had expected that Kraken would offset natural declines at some of its other North Sea assets. Yesterday it said that production last year fell by 5.9 per cent to 37,405 barrels of oil per day. That, coupled with a lower sale price for its oil at $52.20 per barrel compared with $63.80, meant a 25 per cent decline in revenue to $635.2 million. As a result there was an underlying pre-tax loss of $99.5 million compared with a $116.3 million profit in 2016.
However, there are signs Kraken is now on course to grow production. Production from the field was running at 38,000 barrels per day in January and February. Enquest expects its portfolio, which includes sites in Malaysia, to deliver between 50,000 and 58,000 barrels a day this year. It has already hedged a proportion of those at $62 per barrel. The uplift in production should allow the company to chip away at its $1.99 billion debt. Selling up to 20 per cent of its 70 per cent share of Kraken, where Cairn Energy is the other partner, could also trim debt.
While the overall bill for Kraken is some 25 per cent lower than initially forecast at $2.3 billion, there is a bit of spending to be done this year. Additional work that will take output up to 50,000 barrels per day is likely to be completed early next year.
Total capital spending for 2018 is pencilled in to be about $250 million, which includes drilling and workover programmes to improve production at other North Sea sites. And in spite of the strains on its balance sheet, Enquest has still managed to do deals. It hopes that the acquisition of the Sullom Voe oil terminal and Magnus field from BP, which completed late last year, will start to pay off in 2018.
Four years ago Enquest shares were more than 140p and in spite of a 6 per cent rise yesterday they are only at 33p. Analysts at JP Morgan Cazenove are optimistic and have a 41p target price on the shares.
Advice Hold
Why If oil price is supportive and Kraken keeps moving ahead, there could be upside.
