The Rise Of Ocado: Share Price Focus And Where Next For The UK’s Own Tech Stock Star?

by Jonathan Adams

The biggest U.S. tech stocks, along with their peers and competitors from China, often appear to have taken over the world. There is a strong case to say that the FAANGs of Facebook, Apple, Amazon, Netflix and Google (Alphabet) plus Microsoft, which is again the biggest company in the world, and China’s giants such as Tencent, Alibaba, Baidu and Huawei have, over the past decade, become more powerful than many governments.

They certainly bring in more revenue than many countries generate GDP. In 2016, Microsoft’s revenues added up to more than Slovakia’s GDP, Facebook’s surpassed Serbia’s, Alphabet turned over more than Puerto Rico and Amazon than oil and gas rich Kuwait. And China’s big boys are now on the same kind of level.

Whether or not the world’s tech giants now have more wealth and power than is healthy is a question for another day. Today we’ll look at a tech stock from the UK that has been around for some time now but has really started to shine over the past couple of years. Of course, we’re talking about Ocado – the company that started out as an online groceries shopping start-up and is now blooming into a global leader in logistics and warehouse technology. Some analysts believe Ocado could go on to become the UK’s first really big tech stock in the international context.

With the UK’s fintech scene now also taking off, Ocado is not the only domestic hope for a tech powerhouse but for now it’s leading the charge. Today we’ll look at what respected analysts see as the future for Ocado and just how high its share price could fly in years to come, as well as the risks that could bring it crashing back to earth with its wings clipped.

Online Groceries Shopping – A Growing Market Still Lagging Wider Ecommerce Traction

Ocado isn’t quite a tech ‘start-up’. This is an overnight success story that has been 19 years in the making. Ocado was founded in 2000 by three co-founders, all ex-Goldman Sachs bankers. Ocado started out as a pure online groceries delivery company, building up slowly in what was during the early years still a very niche market. In 2000, when Ocada launched, data company Statista figures show that only 25% of UK households actually had their own internet connection.

It’s been a long a long and winding road since. Of the original 3 co-founders, only CEO Tim Steiner is still with the company. Having made it into the FTSE 100 in 2018, Steiner, who still holds around 3.7% of the company, is now one of a small, elite group of co-founders to have genuinely taken a company from nothing to blue chip status.

Ocado made the leap into the lofty echelons of the FTSE 100 by roughly doubling in value over the course of 2018. An achievement all the more notable for the fact the year was generally a depressing one for stock markets. And especially tech companies, where a heavy sector sell-off dragged down the wider market between autumn and the end of the year.

Until 2018, it is fair to say that Ocado’s share price did not benefit from being a darling of the City and stock market analysts and columnists in the mainstream media. When Ocado was still only an online groceries business, even after it had established a partnership with Waitrose, it was dismissed as a middle class indulgence. Few observers foresaw the extent to which the online retail and deliveries market would develop over the past several years. At least not when it came to groceries shopping. Despite the fact that, really, groceries shopping online makes more immediate sense than clothes shopping and many other online retail sectors that have become commonplace.

Most households view groceries shopping as more of a necessary evil than enjoyable in the same way as buying consumer goods is for many. And most groceries shopping consists of products the buyer is already familiar with.

And while online groceries shopping has grown at a steady pace over the years it still, according to market researcher Mintel, only accounted for 7% of the UK market in 2018. Part of why online groceries shopping had seen slower adoption than other niches in online retail is the demographic of groceries shoppers. On average, the main groceries shopper in any given British household has possibly not been the most digitally savvy member of that household.

There is also the factor that while some households do plan weekly groceries shops well and only make occasional ‘small shops’ for missing ingredients or oversights outside of that, many also do groceries shopping on an ad hoc basis. Online shops often involve a fee unless over a certain minimum and there has to be a degree of coordination so someone is at home when a delivery is due to be made. So doing several smaller online groceries shops a week perhaps seems like more trouble than saves.

But online groceries’ shopping’s share of the market is growing. In the UK, it’s expect to account for 10% of the entire groceries market by 2023 – a value of around £19.8 billion, which would represent 60% growth over 5 years.

It’s a trend presumably being driven by the demographic shift of digitally savvy, e-commerce veterans growing up and more likely to be responsible for keeping their household’s food supplies well stocked. That’s an assumption borne out by Mintel’s market intelligence, which finds 61% of the 25-34 year olds demographic say they do some of their groceries shopping online and 27% doing ‘most’ of it online.

The over-45s demographic is still, however, proving a drag on adoption. 35% of this demographic have at some point tried online groceries shopping but 42% say they have never and have no interest in doing so. That’s actually an increase from 34% of over 45s responding in the same way back in 2015.

Ocado Transitioning From Online Grocer Into OS For Online Groceries Services

Another factor in favour of a growing market for online groceries shopping is that it is becoming more efficient – both from the shopper and retailer’s point of view. As the market grows, economies of scale are kicking in, making servicing online orders cheaper for providers and consumers. As well as the baseline reality that it’s cheaper on a per delivery basis when grocers have more to make, the logistics systems behind the operation are improving. And it’s here that Ocado is coming into its own.

Ocado survived and grew through its first decade and a half of existence because it was a pace-setter in the UK’s online groceries market. But the groceries market, perhaps more so than any other, is one influenced by utilities of scale. Ocado was never going to be able to compete on price with the big supermarket chains. The company quickly realised it would even struggle to survive as a stand-alone ‘online only’ supermarket and instead established a long-term, exclusive partnership with premium supermarket chain Waitrose. Waitrose’s customer base was in any case far less price sensitive than the mass UK groceries market.

The tie-up was a marriage of convenience. It meant Ocado could generate enough income to remain viable while it became a publically-listed company and worked on longer term plans. And Waitrose, much smaller than the major UK supermarket chains with a 5% market share and targeting a niche, more affluent demographic, was able to offer a top online service without investing

Shortly after Ocado listed on the London Stock Exchange in 2010, one City analyst is reputed to have pithily commented:

“Ocado begins with an ‘o’, ends with an ‘o’ and is worth zero.”

Over the following years things didn’t improve much for Ocado’s share price and perception of the company’s long term future. In 2013 and into 2014 the stock gathered some momentum as the online groceries market grew and a further tie-up was announced, this time with Wm Morrison, the UK’s fourth largest supermarket . But momentum fell away again as the growing market translated most into growth for the biggest players such as Tesco, which had invested significantly in their own online offering. High delivery charges and minimum spends were also still hampering market growth more generally.

By 2017, Ocado was one of the most shorted stocks in Europe. But that quickly changed in late November 2017. Between November 24th 2017 and April 18th 2019, Ocado’s share price surged from 238.7p to 1398p – growth of 486% in less than a year and a half. It was the best performing stock on the London Stock Exchange in 2018 and started 2019 in similar fashion. The share price has since dipped back to 1167p but City analysts are now raising their targets. Ocado’s shorters have scuttled off, many of them presumably nursing the pain of considerable losses.

So what changed? How did Ocado suddenly become the UK’s hottest tech stock after years of treading water, keeping afloat but with little sign of a rescue boat appearing on the horizon?

The simple answer is that it pivoted its business model under the guidance and steely determination of CEO and co-founder Tim Steiner, who had been quietly working in the background, refusing to give up on the potential he had originally seen in Ocado. This year Ocado announced a new delivery partnership in the UK, following the expiry of its agreement with Waitrose. Ocado is now providing a similar service to Marks and Spencer customers as it did for Waitrose’s. And the supermarket has also paid a premium for a 50% stake in Ocado’s own online groceries business, which it has continued to operate on a modest scale throughout its Waitrose tie-up.

But that’s not the development that has turned Ocado’s fortunes around, though it has provided a welcome cash injection. M&S has an even smaller share of the UK’s groceries market than Waitrose. In fact, it’s not groceries sales at all that is now driving Ocado’s growth. It is licensing the cutting edge groceries delivery logistics technology it has been developing behind the scenes over the years that has now suddenly catapulted Ocado into the big leagues.

Ocado Now More A Logistics Tech Company Than An Online Grocer

How long Ocado’s hugely successful pivot has been part of Mr Steiner’s long term vision for the company or whether it was a somewhat lucky break forced on management as the core groceries delivery model failed will probably always remain at least somewhat open to debate. Regardless, it is working and Ocado’s direct experience in the UK grocery deliveries market over almost two decades now has undoubtedly helped the company hone its technology suite.

Ocado has developed warehouse robotics and processes and a software suite that automates much of the logistics behind fulfilling online groceries orders. They have basically built an OS that has become an industry standard. Ocado originally tried to mesh third-party software with their warehouse automation hardware. It didn’t work well and the decision was made to develop their own proprietary end-to-end system.

It is somehow fitting that before Ocado was Ocado, its co-founders originally named their pilot company ‘Last Mile Solutions’. Ocado’s success over the past few years has been based on licensing its know-how, software and warehouse robotics, which are focused on the automation of last mile delivery logistics, to large international supermarket groups. As recently recalled in a Financial Times column, Steiner likes to boast about how:

“Ocado algorithms work out not only where and when your punnet of raspberries was crushed, but who keeps crushing them. The hapless employee will then receive a data-backed remedial lesson in best warehouse practice, all in the interest of customer service. Research is under way to reduce human input, and possibly eliminate humans altogether, for the moment when time-poor shoppers want to welcome driverless Ocado vans to their streets”.

Source: Ocado

There is also potential for Ocado to license into non-groceries ecommerce as ‘last mile’ delivery becomes a quickly growing part of the deliveries logistics chain in answer to consumer demand for same-day, preferably within hours, receipt of online purchases. The biggest online retailers such as Amazon see having the most efficient last mile deliveries network as a key competitive advantage and also one of the most important factors to increasing the online share of retail more generally. Amazon’s recent investment in UK takeaway and restaurant meals delivery company Deliveroo is seen as motivated by the priority it is placing on its last mile competency and capacity.

But the company’s been doing well in the groceries market over the past couple of years. Flagships deals with France’s Casino and Kroger in the USA to build and run custom warehouses using the Ocado system, licensing it for the rest of their logistics infrastructure, are worth hundreds of millions of pounds. There are also smaller deals with Canada’s Sobeys, Sweden’s ICA and more are expected to follow.

Ocado could well become to online groceries and other last mile logistics processes what Android is to smartphones – the market leading OS.

How High Could Ocado’s Share Price Go?

Where Ocado’s share price goes from here will depend on the pace at which it continues to sign up international partnerships and the strength of competition from competing logistics technology systems. But City analysts have certainly largely turned coat and are now bullish on the stock.

The Financial Times consensus of 13 analyst estimates for Ocado’s share price puts the median price target at £10.00. However, 45.7% of those analysts have a high estimate of the stock reaching £17.00 within the next 12 months. 6 of the 13 recommend Ocado as a ‘buy’ and 2 as ‘outperform’. Just 3, 2 and 3 analysts rate it as a hold, underperform or sell recommendation respectively.

If Ocado continues to get signatures on major new partnership agreements over the next couple of years, the UK will finally have its own world leading technology stock.

This article is for information purposes only.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.

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