Ocado Group plc (OCDO) Ordinary 2p

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Ocado’s third-quarter revenue grew 15.5% to £658mn driven by higher volumes, average orders per week and active customers. This marks the seventh consecutive month as the UK’s fastest-growing grocer.

Average selling prices declined 0.4%, as Ocado chose to invest to keep price growth below the 2.0% UK grocery inflation rate.

Full-year revenue growth guidance has been raised to low double-digit rates (previously mid-to-high single-digits). All other guidance remains unchanged.

The shares rose 8.0% following the announcement.

Our view

Ocado’s third-quarter update showed that sales momentum’s moving in the right direction, leading to an improved full-year outlook.

But future growth rests on its so-called Technology Solutions business. Last we heard, this segment has seen some of its retail partners press pause on plans to open more Customer Fulfilment Centres (CFCs). That saw analysts trim their expectations for future growth, leaving the Group’s path to profitability a little unclear and denting investor sentiment.

CFCs are the cornerstone of Technology Solutions. The group charges third-party retailers to use its robotic systems. Hundreds of thousands of orders are processed each week, with the help of automated 'bots' scurrying around the trademarked grid systems.

Running operations through Customer Fulfilment Centres (CFCs) brings a host of cost savings and efficiency benefits that could offer a competitive advantage for those who can afford it. But the current economic outlook poses challenges, putting pressure on existing and potential partners to cut unnecessary spending.

The group is also under pressure to establish a long runway of CFC openings because Ocado is stumping up hundreds of millions to fund these centres. This has led to significant fundraising from shareholders. Medium-term plans for free cash flow generation from existing CFCs seem ambitious to us, and we can't rule out Ocado burning through its available liquidity faster than planned.

Ocado's smaller retail business - the grocery delivery company half-owned by M&S - is continuing to perform well, with profitability improving substantially in the first half. Customer numbers have now passed the one million mark and volumes are showing impressive growth.

But there are things to monitor. Growth in retail sales has been driven by the increased customer numbers rather than letting price hikes do the heavy lifting. We approve of the positive customer value perception this creates, but raising prices slower than UK grocery inflation is putting downward pressure on profitability. It’s a tough balancing act and careful management on this front will be required to hit the group’s margin targets.

There’s also potential legal action with M&S over a withheld £190mn performance payment, after pre-defined targets weren’t met. We’ll be following this closely, but regardless of the outcome, it’s hard to imagine it will benefit relations.

We should be clear - Ocado has an amazing product. It's the only global provider of an end-to-end, online grocery platform. As the group builds scale and partnerships mature, profits and free cash should flow. We just aren't convinced this will happen in the projected timeframe. This could result in further knocks to the valuation, which has already fallen significantly over the last year on a price to sales basis.

Environmental, social and governance (ESG) risk

The retail industry is low/medium in terms of ESG risk but varies by subsector. Online retailers are the most exposed, as are companies based in the Asia-Pacific region. The growing demand for transparency and accountability means human rights and environmental risks within supply chains have become a key risk driver. The quality and safety of products as well as their impact on society and the environment are also important considerations.

According to Sustainalytics, Ocado’s management of ESG risk is average.

The group has an adequate environmental policy and its whistleblower programme is strong. However, ESG reporting falls short of best practice and the group lacks regular risk assessments on data privacy.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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