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  1. Analysis
July 22, 2010

Analysis: Raining on Ocado’s parade

Ocado finally got its IPO away yesterday (21 July), although the market appeared sceptical about the plans CEO Tim Steiner and his team have for the UK online retailer.

Ocado finally got its IPO away yesterday (21 July), although the market appeared sceptical about the plans CEO Tim Steiner and his team have for the UK online retailer.

The company’s shares floated at 180p each (already lower than management’s initial target; they had set a range of 200p to 275p) but the stock quickly fell and, at 11:55 BST today, they were trading at 160p.

The initial performance of Ocado’s shares came after weeks of fierce criticism from some parts of the City over the retailer’s plans to list and its valuation of the business.

The valuation, based on an ambitious 16x November 2012 EBITDA/EV multiple, combined with its unwillingness to meet with analysts at banks unconnected to the IPO, created hostility in the market, laying down the gauntlet for critics to seek out flaws in the listing.

And with the risk factors outlined in Ocado’s prospectus reaching a mind-boggling 18 pages, it’s not been hard for critics to find them.

Added to the mix the fact that the company is yet to make a pre-tax profit and that no grocery retailer has yet make a clear profit from its online operations put its plans on even shakier ground.

Even though rival Tesco claims to make money from its operations, whether it actually does or not depends on whether the costs incurred by its online operations are charged to it or its stores.

The online grocery channel, which is set to continue growing and is set to grow 34.4% to be worth GBP20.10bn by 2014, is not without opportunity.

However, with the cost of picking and packing online orders reaching GBP4.20 and the real cost of delivery being closer to GBP8.40 than the GBP2-7 being charged by Ocado, the already tight margins in grocery retail take an even larger hit when all of this extra work is accounted for.

There are also issues around future competition in the channel. Ocado’s non-competition agreement with Waitrose ends next year, and it’s hard to imagine that the upmarket retailer will not begin operating inside the highly lucrative M25 region.

Much of Ocado’s private-label proposition hangs on its relationship with Waitrose and the online retailer’s deal to sell its partner’s goods was recently extended until 2020. However, with Steiner’s focus determinedly set on the immediate future, he has not revealed what what will happen beyond this time.

With Waitrose likely to extend its Waitrose Deliver service into the M25 region from 2011, what motivation will there now be for customers to use Ocado’s service?

Oriel Securities analyst Jonathan Pritchard said that with competition hotting up in the London area, Ocado’s growth will have to be generated from more outlying parts of the UK.

However, with 80% of Ocado’s sales being located in the London area, all of this relies on its planned customer fulfilment centre in the Midlands being constructed quickly and without any hitches.

Steiner put the company in the same leagues as online behemoths as Apple, Amazon, Asos and Google. While Amazon had not yet made a profit when it launched its IPO and said it did not expect to make one for five years after listing, Oriel Securities analyst Jonathan Pritchard hesitated to liken their growth prospects. “For every Amazon there are at least five similar companies that disappointed the Stock Market,” he said.

Nobody is questioning the quality of Ocado’s offer – it has innovated in its sector with its fantastic customer service, great customer proposition and seamless user interface, but we can only hope that it turns all of this into a profitable business model.

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