Ocado may be the eternal jam tomorrow story. Another planned jump in capital expenditure this year will cause earnings at the grocery delivery specialist to be about £30 million below market expectations, dashing anybody’s hopes for annual growth.
The FTSE 100 constituent is ploughing cash into rapidly building online fulfilment capacity on behalf of third-party retailers and its own joint venture with Marks & Spencer. The result last year? A tripling of pre-tax losses to £177 million.
That much was expected by analysts, but almost doubling the number of customer fulfilment centres to 19 by the end of this year and increasing the capacity at some of its existing warehouses means that capital expenditure is set to rise by almost a fifth to £800 million. The international business will bear the brunt of that, with eight warehouse launches resulting in losses as wide as they were last year. Numis, the broker, has reduced its forecast for group ebitda — earnings before interest, taxes, depreciation and amortisation — from £90 million to £60 million for this year.
• Ocado loses all its pandemic gains
Revenue growth slipped back behind cost growth once again last year. 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. The problem for Ocado’s bottom line is that there is a natural lag between funding the fitting out of facilities and the associated sales capacity reaching full potential.
Ocado is playing the long game. Justifying its heavy investment and being able eventually to fund capacity growth through cash generated by the business will depend on revenue continuing to grow at a clip.
Investors have already dismissed the possibility that sales rates will remain at pandemic-era highs. An enterprise value of 3.8 times sales for the next 12 months, and 95 times forecast ebitda, are back at 2019 levels. A 15 per cent fall off the back of full-year results takes the total share price decline to almost 60 per cent from last year’s near-record high and has wiped nearly all the gains made since the start of 2020. But it would take a far bigger sell-off to make Ocado look anywhere near reasonable.
Revenue growth slowed to 7 per cent last year, as customers of its retail business, which accounted for 92 per cent of the group total, spent less time hunkered down at home. That business had accelerated the opening of new warehouse facilities as a bet on online grocery shopping remaining above pre-Covid levels. Tim Steiner, Ocado’s founder and chief executive, points to a two-year sales comparison of 41.5 per cent for last year, but that includes some lockdown impact. It’s still early days and that two-year rate of growth also slowed throughout last year, at 31.6 per cent during the fourth quarter, against 51 per cent during the first six months of the year.
There’s a chance that a slowdown in sales could continue for the high-end grocery retailer, particularly as real incomes come under pressure from rising inflation. People tend to reduce the amount they eat out before what they spend on grocery shopping, reckons Steiner, who is not expecting to see any reduction in demand based on inflation or the cost of living squeeze. But there is also the prospect of rising competition. Even if a greater number of shoppers do stick with buying more goods online, the pandemic was also used by major supermarkets to finesse their online channels.
Inflationary pressures are easing for the retail business, according to Steiner, and labour shortages are improving. Yet the margin will remain depressed this year as the company spends an extra £50 million on developing its warehouse facilities. Higher orders but a lower average basket size doesn’t bode well for margins either, with more drivers needed for the same volume of goods. There is easily the chance that Ocado will deliver disappointment on earnings.
ADVICE Avoid
WHY A high market valuation together with large costs and slowing revenue growth could cause the shares to weaken further
DCC
For a business that’s gained a reputation among investors as a steady performer, any hint of earnings pressure is always going to spook the market. For DCC, the sales and marketing specialist, that has translated into a share price/forward earnings multiple of 15, near the bottom of the five-year range.
The Dublin-based group sells and markets goods across a hodgepodge of industries, spanning medical instruments and beauty products to gas and electricity to households, over three continents. Wage inflation, rising freight costs and higher energy prices are a natural risk for a group with such slim margins, but those challenges are not expected to unseat profit recovery this year.
Rising distribution costs and other inflationary pressures are being recouped through price increases. Roughly 80 per cent of energy-related sales are made at the daily spot price, but the remainder are based on contracted prices. Price increases will come eventually, but in the meantime DCC will take the pain. Nevertheless, higher wholesale energy costs pose a challenge, especially to the liquefied petroleum gas business, the largest contributor to profits. A recovery in demand from commercial customers as businesses reopened helped to mitigate the impact during the first half of the year.
Analysts at Peel Hunt forecast a dip in the operating margin to 3.8 per cent this year, before a return to 4 per cent during the next. But revenue is expected to be £15.2 billion, a 14 per cent rise on last year and back at pre-pandemic levels, while adjusted pre-tax profits will be 12 per cent higher.
The strategy has been to gain market share in a small number of countries before expanding elsewhere. The support services group is heavily acquisitive and has the balance sheet strength to continue buying companies, with a net debt position forecast to remain low at only 0.4 times earnings before tax, interest and other charges at the end of March.
DCC has a solid record of putting cash to good use. Over its 27 years as a listed company, it has generated compound annual revenue growth of 14 per cent and an average return on capital employed of 19 per cent.
ADVICE Buy
WHY Good value for a reliable growth generator
