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Ocado investors hang high hopes on tech transformation

Ocado has signed multiple overseas partners in recent years but the market wants to know how much money it can make from these deals, according to AJ Bell's Russ Mould.

Ocado's investments in innovations have paid off

Ocado Group PLC (LON:OCDO) suffered a setback after a fire ripped through its Andover warehouse in February but many investors remain bullish about the stock as the company grows the technology side of the business.

Since Amazon entered the grocery scene, supermarkets have been calling on Ocado to help set up their online delivery service.  

Deals with Marks and Spencer Group PLC (LON:MKS) and Australian supermarket Coles this year have pushed Ocado’s shares up 55% since the start of 2019. 

READ: Ocado earnings hit by Andover fire costs but shares jump on deal optimism

The contracts follow deals with France’s Casino, Swedish grocer ICA, Kroger in the US and Sobeys in Canada in recent years. 

But investors were not always optimistic about Ocado.

The beginnings of Ocado 

Ocado built its technology from the ground up, including everything from consumer facing websites to robots operated warehouses.  

Early critics lambasted the company’s decision to heavily invest in creating its own technology, raising concerns about what they considered to be a high-cost business model with limited growth prospects.

Ocado, founded in 2000, started out as an online grocery business that sourced its goods from Waitrose before reinventing itself as an automation-focused technology firm.

At first, Ocado planned to keep its technology to itself.

But three years after it listed in 2010 on the London Stock Exchange, Ocado decided that selling the technology would not only boost revenues but prevent other retailers from copying.

In 2013, the company agreed a tie-up with WM Morrison Supermarkets PLC (LON:MRW) to set up the supermarket chain’s online grocery delivery service.

Investors wanted to see more third-party deals but Ocado was not yet equipped to take on multiple retailers.

At the time, Ocado brushed off market scepticism over the failure to secure more partnerships and focused on developing its technology.   

It wasn’t until 2017 that Ocado signed a long-awaited licensing deal with international customer, Casino.

Not too long after, further deals came flowing in and investor confidence grew, propelling Ocado's shares higher.

Andover blaze hit shares but only temporarily 

In February, Ocado saw £1bn wiped off its market value after a fire destroyed its Andover warehouse, which handles 10% of its capacity.

However, shares have since recovered after Ocado announced a deal to spin off its legacy UK grocery retail business into a £1.5bn joint venture with M&S.

M&S will spend £750mln to buy a 50% of the joint venture and some analysts have questioned whether the company has paid too much to get into the growing internet grocery business.

The joint venture will begin trading in September 2020, when Ocado’s deal to supply Waitrose products expires.

Analyst raises concerns about M&S deal 

James Yacoub, retail analyst at data and analytics company GlobalData, commented: “Following the announcement of its 50/50 joint venture with M&S, Ocado’s share price rocketed to its highest level in the online pureplay’s history, indicating that it may have got the better half of the deal.

“However by cutting its ties with Waitrose, Ocado has potentially traded a chunk of its loyal customer base for a deal with a retailer that is struggling, as its food sales continue to decline.

“There are little tangible signs to indicate that M&S has the same potential foothold as Waitrose in the online food & grocery market, which has led speculators to question whether the £750mln paid for the joint venture was simply too much and that it may be anchoring on to Ocado to help turn its fortunes around.”

Yacoub thinks Ocado’s recent £17mln investment into vertical farming is a “step in the right direct”, particularly as the grocery sector becomes more focused on sustainability, but he noted that the retailer must ensure the investments it makes can be maintained in order to ensure the longevity of the business.

On top of its move into vertical farming, Ocado plans to go head to head with Amazon by launching its own one-hour delivery service, called Zoom.

Technology investments pay off in first half 

The continued investments in technology led to a 20.6% jump in revenue from the FTSE 100-listed firm's Ocado Solutions tech business to £70.8mln in the first half. Fees invoiced from partners amounted to £122.7mln in the same period, up 36% on a year ago.

Analysts at Peel Hunt see the potential for Ocado to become the “Microsoft of Retail” through the sale of its technology.

"This is the key performance indicator that investors should focus on as Ocado Group makes the dramatic transformation from a transactional online retailer to a software and deep tech hardware business,” they said in a note to clients, leaving their 'buy' recommendation on the shares unchanged after Tuesday's trading update.

Market wants to see profit from deals 

AJ Bell investment director Russ Mould said Ocado has laid the foundations for its future by signing up multiple overseas partners over the past few years. However, he added, the market wants to know how much money it can make from these deals and when they will start producing a profit. 

“The big challenge is getting these international technology deals up and running without any hiccups,” Mould said.

“An electrical fault in a battery charging unit causing one of its robots to catch fire and destroy a warehouse earlier this year won’t have helped Ocado’s reputation. However, management will have been able to learn from the situation and strive for greater safety measures in the future.”

Mould thinks Ocado’s investments in innovations put it on the right track to achieve its ambitious growth targets but stressed that the company needs to “turn the magical promise into profit”.

Quick facts: Ocado Group PLC

Price: 2865 GBX

Market: LSE
Market Cap: £21.43 billion

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