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UK online venture is big deal for M&S but investors unconvinced

UBS analysts said the UK joint venture makes up less than 10% of their Ocado valuation

Ocado Group PLC -
Ocado's robots are now mostly handling M&S productsfeat

A positive trading update on its UK business from Ocado Group PLC (LON:OCDO) sent its shares up noticeably higher than Marks & Spencer Group PLC (LON:MKS), which is a 50-50 joint equity owner of the business.   

This comes with Ocado’s shares trading at a multiple of around 300 times earnings and M&S available on a forward p/e of 16 times.

What makes this more strange is that analysts say the UK online grocery JV means more to M&S than it does to Ocado, where it’s sky-high valuation is more, or entirely, based on selling its technology to overseas supermarket groups. 

Indeed, UBS analysts clarified that the Ocado Retail JV makes up less than 10% of its valuation.

READ: Ocado says M&S products proving popular as sales growth remains strong

The Ocado Retail update revealed retail revenue was up 52% to £587.3mln in the past quarter, with average basket sizes slightly normalising from post-pandemic peaks, but higher number of orders per week as a result of strong demand and the reopening of the Ocado website to new customers. 

M&S-branded products on the site have been received well since going live at the start of September, with the weighting of M&S products in a basket is higher than the Waitrose weighting before the switchover, and 98% of customers are already shopping M&S. 

“This counters the bearish point that customers would turn off once Waitrose left the site,” said analysts at broker Peel Hunt. 

The JV is focused and apparently on track to increase its capacity by 40% through to 2021 and, while previously guidance for the Ocado Retail JV had been withheld given the unusual levels of demand, today the FTSE 100 group was happy to say that as a group overall it expects to generate underlying profit of at least £40mln.

For the full year, the Vuma consensus forecasts had been for group EBITDA is £30mln.

Russ Mould, investment director at AJ Bell, said the joint venture seemed to have got off to a good start, depending on how you look at the situation, with strong sales but a launch that was marred by order cancellations as frustration for some long-standing customers boiled over at having to wait for a delivery slot.

“The timing of the joint venture’s operations going live couldn’t have been any better,” he said though. 

“Marks & Spencer has effectively flicked the switch exactly at the point when people across the country have become reliant on ordering groceries online. Just imagine if it hadn’t had the deal with Ocado in place – Marks & Spencer would have looked foolish for being the one UK food seller woefully behind with its digital strategy at a time when there has been a radical shift in consumer behaviour.”

He said it was also important for Ocado, “as it effectively passes the baton to the supermarket partner so it can truly concentrate on providing grocery systems to third parties globally and finally shake off that reputation of being a van driver delivering food and drink to people’s homes”.

Analyst Clive Black at M&S’s house broker Shore Capital agreed it was fortuitous timing, especially with the food and clothing retailer having so many stores in city centre locations where footfall has dropped dramatically in the pandemic.

“Of all the British grocers, M&S has a business model where Ocado could bring particular capability around the full online shopping basket proposition. Put another way, before the September launch with Ocado Retail, M&S' Food range and most of its stores were not really compatible with the store picking model pursued by its rivals.”

There were no hard and fast numbers since the M&S product launch, however, so it remains to be seen how much of a difference it makes to the FTSE 250 retailer.

The growth rate is likely to slow as people are encouraged to go back to work and eat out more, therefore less food will be likely consumed at home, said Russell Pointon at Edison Group, who also observed that the retailer's distribution centres are running at a high level of capacity.

“Going forward, investors will be keeping a close eye on the [JV's] level of demand and if it can be sustained, particularly following the extensive advertising campaign ahead of the launch,” he added.

Furthermore, it remains to be seen how ‘sticky’ online shopping will prove, with fresh Kantar industry data showing online grocery growth continued to slow, down to 12.5% of total sales this month from a peak of 13.5%. 

However, with year-on-year growth of 77% it still remains massively elevated than before the pandemic.

Either way, as Mould says, the joint venture is a “huge deal” to M&S, but “just a cog in the machine” for Ocado, which makes the share price action a bit of a head-scratcher. 

Moreover, M&S directors seem to be showing a similar lack of confidence in the shares as the wider market, with only two board members, strategy director Katie Bickerstaffe and senior non-exec Justin King, having bought any shares in the open market since the price collapsed in March. 

Quick facts: Marks and Spencer Group PLC

Price: 104.25 GBX

LSE:MKS
Market: LSE
Market Cap: £2.04 billion
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