Ocado – Unexpected items - Positioning
All,
Please see our updated analysis here.
Ocado has been rocked by the decision by Kroger to review its online strategy. We think the impact on the SUNs is relatively small, as we still see a significant equity cushion. As the Technology business doesn’t generate Free Cash Flow yet, the DCF calculation is volatile, but we see the bonds as being covered by the enterprise. We have built in an assumption that Ocado will raise a further £300m in equity to bolster its liquidity position.
Investment Rationale:
- We are taking 5% in the 11% Aug-30 SUNs at 95p/£, we see 5 points of upside and 5 of downside, but an 11% coupon makes the total return attractive.
- Our 3% long position in the 0.75% £350m Jan-27 has given us a total return of 14% since September 2024 (we bought in at 80.5p/£ and the bond now trades at 91.2p/£ + 0.75% in coupon). We do not expect this low-coupon instrument to be called early, but there will be a pull to par next year. We see 10 points of upside and little downside unless there is a significant negative re-rating of the credit.
- We are going to invest now; there will be no further data from Ocado until February 26, 2026. The Kroger strategy announcement in November may cost us a couple of points, but we think the bonds will recover quickly.
- The 50% of the retail JV is worth about £500m to Ocado. The Technology business is worth around £2.5bn, which covers the debt. However, Technology is some years from generating consistent free cash flow, making the valuation very sensitive to any delay in the build-out.
- The fact is that this will shuffle along for some time before cost and value become clearer, but there is still a significant equity cushion behind us.
Key Conclusions:
- Our Company section highlights that Ocado is trying to move from being valued as a grocer to being valued as a logistics/IT company. The Technology business will be the primary generator of revenue and cash in the future, with additional fee income from the Morrisons and M&S JVs. We do not expect M&S to immediately buy out the 50% of the JV it doesn't own, but we expect a deal to be done in the next few years.
- The DCF valuation of the business is a challenge, as most of the period covered is covered by negative or limited cash flow generation. We see the SUNs as fully covered and the equity value at 156p per share. The M&S JV represents 30% coverage, with the remainder coming from the Technology business.
- The valuation is currently highly sensitive to assumptions as to when the Technology business begins to generate consistent cash flow.
- As our Risk and Value section shows, Ocado has 20 years of operational experience behind it; the growth in online grocery and demand for automated fulfilment centres is a major growth opportunity for the Technology division. Grocers also want to use their store footprint, but the efficiency and density of CFCs will mean they will continue to be core to online fulfilment.
- As we note in our Trading section, the main talking point after the H1 25 results was Kroger’s decision to look to use more in-store fulfilment. This could lead to a slowing in the CFC rollout, but we do not see a replacement of CFC capacity with in-store fulfilment.
- The refinancings done in the last 12 months have been painful in terms of coupons. Gross interest is now £100m (net will be closer to £90m). We think another £300m in equity may be needed to provide a buffer, but we expect this would be sellable.
- A significant amount of the £750m cash on hand is tied up in prepayments from partners, but we are not concerned that this cash can be called back as long as Ocado is delivering on the CFC rollout as expected.
- Online is the fastest-growing segment in the grocery business. CFCs are capital-intensive, and some grocers are looking to preserve cash by leaning on their store portfolio for in-store fulfilment of online orders. Speed of fulfilment, picking efficiency, and inventory density, along with greater scalability in CFCs, will ultimately push more of the orders out of stores.
Kroger review is negative, but not terrible:
- Kroger is reviewing its remaining CFC investment and leaning towards in-store fulfilment.
- The impact could be a reduction in revenue of £110m and EBITDA of £65m by FYE 2030. This would assume these orders are lost, not delayed, and not replaced with CFC roll-out from other clients.
- We see a potential slowing of orders, and growth in online orders (16% at Kroger last year) would quickly overwhelm stores.
- With a store footprint around 50% the size of Walmart’s, Kroger needs CFCs to grow. However, it is looking to preserve cash after the failed Albertsons merger.
- The issue is cost, not performance, and we expect other grocers to want to continue rolling out their platforms.
- CFCs are expensive but efficient: An average CFC will have 5 modules at £10m each => £350m of sales capacity. The sales capacity per module is growing as the robots are upgraded.
Recent Trading H1 24/25:
- Technology Revenues of £277m were ahead of our expectations, and this is reflected in EBITDA of £73m vs our forecast of £51m (excluding Ocado Retail). Capex of £213m was £100m less than our forecast, which reflected lower module additions.
-The deconsolidation of the Ocado Retail business will remove much of the noise around what is predominantly a logistics business. The book value of the 50% share in the Ocado Retail business is £750m (we had valued it at £800m), and the division will be accounted for as an equity investment in the future; we expect M&S to look to buy out Ocado at some point, which will leave an income stream similar to the Morrisons JV.
Kroger E Commerce Review:
- Kroger’s review of its e-commerce strategy (announced in September 2025) is driven by the need for e-commerce profitability as opposed to disenchantment with Ocado; E-commerce sales grew 16% YoY vs 3.4% overall (excluding fuel). The review announced on the Q2 results call will focus on increasing the use of the store footprint to pare e-commerce costs and get the platform to profitability. Kroger has already slowed its CFC rollout programme (in 2023), and may change where it locates future CFCs, but we expect the rollout to continue. Kroger doesn’t have the store footprint of its larger rival, Walmart, so a mix of e-commerce sales from Customer Fulfilment Centres (CFCs) and Stores is important. Kroger will provide an update at its next results announcement in early December
I look forward to discussing this with you all.
Regards,
Aengus
T: +44 203 744 7055