Ocado Ltd. (Report Submission)

1. Background1.1 Company BackgroundOcado is an upscale online platform for online grocery shopping that operates within the

UK. It provides a daily service that covers more than 70% of the country’s population and

is considered to be the world’s largest online grocery retailer.

In 2014, the Ocado group rolled out two new online retail sites: Fetch and Fizzle. Fetch is

a standalone online pet store that provides more than 8000 pet products. Sizzle is an

online kitchen and dining outlet that sells premium kitchen products. Since its launch,

Sizzle hosts more than 12000 products (Ocado,2014).

While Ocado can be seen as a online retail company, it can also be viewed as a

technology company. In 2014, the Ocado group entered a 25 year agreement to

implement and provide operating services for their online grocery retail platform to launch

and run Morrisons.com. Based on its success, the company plans to continuing

commercializing its technology in the future (Ocado, 2014).

1.2 StrategyOcado’s main focus has always been to develop the best platform for online grocery

retail. This places Ocado in a unique position and gives them a number of sustainable

competitive advantages.

At its core, Ocado.com, runs its operations on a platform that is unique to any of its

competitors. Developed themselves, the platform is a unique end to end operating

solution for online retail. Ocado has this intellectual property patented, creating a barrier

to entry for grocery retailers trying to enter the online space. To gain access to this

technology infrastructure, traditional grocery retailers either need to develop their own

technology systems or become commercial partners with Ocado.

Ocado Ltd. Financial Analysis Report- 1997 words

Business operations at Ocado are solely focused on online activities. This sets Ocado

apart from many other traditional grocery retailers and provides them many cost

advantages. Firstly, Ocado does not have any brick and mortar stores. This saves on

investing in high fixed cost stores as well as in-store labor costs. Another aspect of

Ocado’s business operation that gives them cost advantages is the use of central

fulfillment centers (CFC). CFCs are where all stock is received and held and all customer

orders are picked. By having everything centralized in one location, Ocado is able to

minimize property and occupation costs and reduce product waste. The service that

Ocado provides to consumers also differentiates it from other competitors. Without the

limitations of store space and shelving, Ocado can have wider product selections at

competitive prices. As of now, Ocado hosts more than 48,000 different products.

Additionally, with faster stock turn and advanced picking systems, Ocado ensures fresher

food being delivered to consumers.

1.3 Industry and CompetitionIndustry Growth RateThe Ocado Group operates within the UK e-commerce grocery industry, a sub-group

within the traditional grocery retail industry. Despite being a relatively young industry,

industry growth has been expanding rapidly over the years. Sales via online super

markets have increased by 81.9% from £4.15bn in 2010 to £7.55bn in 2014 (Key Note,

2014). Key Note estimates that over the next 5 years, the UK internet grocery market will

see double digit growth for each consecutive year, peaking at £21.65bn in sales in 2019.

As more consumers have access to the internet and choose to order groceries online

over stepping into physical stores, internet groceries have the potential to takeover

traditional grocery retail. There is a strong possibility that physical retailers moving online

may cannibalize their existing store businesses.


(Key Note,2014)

Concentration and Balance of CompetitorsWith certain exceptions like Ocado Ltd. and Waitrose, most of the key players in this

industry are the leading supermarket retail chains: Tesco PLC, ASDA Group Ltd, J

Sainsbury PLC. Out of all of participants in e-commerce grocery industry, only Ocado is

fully online based. The rest have a strong presence in traditional retail. Below is a pie

chart that outlines that market share of the UK internet grocery market. As of now, Tesco

Plc is the leading online supermarket business in the UK.


Other smaller grocery retailers are also following this trend, implementing their own

online platforms, creating a saturated highly competitive market. However, the large

demand for the convenience of E-commerce is an indicator that there is still room in the

market for a large number of competitors.

Excess Capacity and Exit BarriersRegardless of the ongoing demand for online groceries and its convenience, food

products in general is price elastic. There is often the case of more supply than demand

(excess capacity). Over the years, the number of different grocery shopping channels

have increased giving consumers wider access to different retailers and to better product

price deals. Apart from price competition between the online grocery retailers

themselves, they also face heavy competition from no frills physical retailers. The profit

margins of these companies often face heavy pressure due to competitive discount

pricing.

While the industry is extremely difficult to compete in, it is also relatively difficult to exit.

Most online grocery retailers in the industry require substantial fixed asset investments in

additional warehousing, technology infrastructure, and vehicles to implement a proper

end to end grocery retail solution.

Degree of Differentiation/ Switching CostsIn general, food products sold in online retail stores tend to be homogenous. Unless it is

premium or of extremely high quality, food products are a commodity. As a result, food

products, can be extremely price sensitive. The price sensitivity of food can be extended

when internet access reduces information asymmetry and online grocery shopping

removes any considerations for store locations. Switching costs in this industry are close

to nothing. Consumers that don’t enjoy the online services of one retailer can simply

switch to another with the click of a button.

Threat of New EntrantsThe infrastructure costs of creating a large online grocery retail business are substantial.

Most of the time, companies hoping to create such online stores are physical grocery

retailers with pre-existing stores. Its not always easy juggling between traditional and

online retail. In fact, a number of leading supermarkets and grocery stores have still failed

to enter the internet grocery market (Key Note).


Buyers Bargaining PowerOnline grocery retail has made the pricing of food products more transparent. It is easy

for consumers to compare and contrast prices from different retailers to find the best

deals. This makes food products more price sensitive and gives buyers more bargaining

power.

2. Financial Analysis2.1. Overall ProfitabilityTable 3.1 shows the ROE based on the reported earnings for Ocado and J. Sainsbury.

Ocado’s ROE in 2014 (5.36%) has shown significant improvement compared to the ROE

in 2013 (-4.02%) and 2012 (-0.72%). This can be explained by increases in net profit and

sales between 2014 and 2013. In 2014, Ocado made a net profit of £ 11.5mil compared

to the net loss of £8mil made in 2013. Sales increased as a result of an increased

customer base from 70,000 to 453,000 (BBC, 2015). The increase in profitability can also

be explained through their monetization of Intellectual property through the partnership

with Morrisons (Ocado, 2014). A positive ROE figure for Ocado is significant because it is

the first year that an annual profit has been reported for the company since its launch in

2000.

Sainsbury has reported a much higher average ROE over the past three years of 17.23%

compared to Ocado’s ROE of 0.21%. This is an indication that Sainsbury’s management

is much better at employing the funds invested by the firm’s shareholders than Ocado.

2.2 Decomposed ProfitabilityTable 3.2 shows the traditional breakdown of ROE for Ocado and J. Sainsbury. In 2014

Ocado’s increase in ROE is mainly due to a large increase in net profit margin from -1%

to 1.21% and to a lesser extent an increase in the asset turnover ratio. The breakdown

also shows how Ocado has a weaker net profit margin, return on assets, and equity

multipiler than J. Sainsbury. Despite of this, Ocado seems to outperform in terms of asset

turnover across the three years of performance. This implies that Ocado is much more

efficient at its use in generating sales with its assets compared to J. Sainsbury. This is

consistent with the company’s strategic dependency on its cost effective online platform.


2.3 Operating ManagementOver the last two years, Ocado’s net operating profit margin has seen a 2.01% increase,

increasing from -0.84% in 2013 to 1.17% in 2014. Looking at the line items as a percent

of sales in table 3.4, majority of the increase in operating margin comes from the

increase in other income of 1.78%. Net operating expenses only plays a small part in the

improvement of operating profit margin, going down by 0.11% (1.73% decrease in CoS

and 1.62% increase in SGA) in 2014. Mainly because of higher profitability, J.

Sainsbury’s operating profit margins are consistently higher than Ocado’s.

In general, Ocado has impressive gross profit margins that show improvement

throughout the past three years. In 2014 Ocado’s profit margins increased by 1.73% from

31.25% to 32.98%. Sainsbury’s profit margins have been consistently weaker than

Ocado’s, this year being 5.7 times smaller. This can be mainly attributed to Ocado’s

efficiency in procurement, evident by the much lower ratio of cost of sales expense to

sales.

Despite the great profit margins, Ocado has relatively high SGA expenses that cut deep

into profits. As a result, Ocado’s net operating expenses have been always been greater

than its sales. For Ocado, net expenses for the past three years have on average been

2.57% greater than its sales figure whereas net expenses for J. Sainsbury on average

have been 4.27% less than sales. Considering that the company is still so young, these

high SGA expenses may be attributed to research and development costs for expanding

and developing its online platform. This may be the case after launching Fetch, Sizzle, as

well as becoming a commercial partner with Morrisons this year.

2.4 Investment Management Table 3.5 shows the Asset management ratios of Ocado and Sainsbury. In 2014, Ocado

became more efficient in its working capital management increasing from -1.54% to

–0.77%. This can be seen by the increase in trade receivables turnover and days’

receivable and a decrease in days’ payable. The increased working capital efficiency is a

combination of Ocado using central fulfillment centers for efficient distribution and strong

supplier relationships. In contrast, Sainsbury showed a decrease in working capital

management from -4.61% to -8.17%.


2.5 Financial LeverageOcado’s liability-to-equity and debt-to-equity ratio are close to unchanged in 2014.

Comparing Ocado’s debt ratios to Sainsbury’s shows that it adopted a less aggressive

debt policy. It can be seen that the debt to equity ratios of both companies are greater

than one, implying that the increase assets invested in are mostly funded by debt instead

of equity.

In terms of short term liquidity, Ocado outperforms Sainsbury in all fronts, suggesting that

Ocado has more available current assets that can be used to repay current liabilities. The

liquidity ratios for both food retailers are below one mainly due to their high asset

turnover rates from having to store perishables.

3. SummaryOverall Ocado’s Cost advantages strategy were not fully reflected in the analysis. Key

performance ratios such as ROE and Net Operating Profit margin were lack luster in

comparison to its peers. The cost strategies designed to keep SGA expenses low has not

been achieved due to large amounts of research and development costs and

perhaps overhead cost inefficiencies. However, Ocado’s central fulfillment centers have

been promising, increasing working capital efficiencies and gross profit margins.

Being one of the big four retail supermarkets, Sainsbury was a good benchmark for

Ocado. Sainsbury draws a number of similarities to Ocado, but is in fact a much larger

company with more sales and profit. Being its first year to make an annual profit, Ocado

has a long way to go to reach the scale and profitability of its peer. Hopefully after a few

more years, Ocado will develop the backbone to maximize its cost efficiencies to raise its

profitability and continue growing alongside its titanic peers.

References


BBC News, 2015. ‘Ocado Reports First Annual Profit’. BBC UK [online] 03 February 2015

Available at: http://www.bbc.co.uk/news/business-31108569

Accessed November 11, 2015

Key Note. (2015) E-commerce: The Internet Grocery market. 2015. [online] Available at:

https://0-www.keynote.co.uk.lib.exeter.ac.uk/market-report/retail/e-commerce-

internet-grocery-market?full_report=true Accessed November 11, 2015

Ocado Ltd, 2014. ‘Annual Reports and Accounts 2014’. [online] Available at:

http://www.ocadogroup.com/~/media/Files/O/Ocado-Group/annual-reports/ocado-

annual-report-2014.pdf. Accessed November 11, 2015


http://www.ocadogroup.com/~/media/Files/O/Ocado-Group/annual-reports/ocado-

annual-report-2013.pdf . Accessed November 11, 2015


http://results12.ocadogroup.com/information/site-essentials/downloads/annual-report-

2012 . Accessed November 11, 2015

Sainsbury Ltd, 2014. ‘Annual Report and Financial Statements 2014’.[online] Available at:

https://www.jsainsbury.co.uk/media/2064053/sainsbury_s_annual_report_and_acc

ounts_13-14.pdf. Accessed November 11, 2015

Sainsbury Ltd, 2013. ‘Annual Report and Financial Statements 2013’.[online] Available

at: https://www.j-sainsbury.co.uk/media/1616189/sainsburys_ara.pdf .

Accessed November 11, 2015

Sainsbury Ltd, 2012. ‘Annual Report and Financial Statements 2012’.[online] Available

at:https://www.j-sainsbury.co.uk/media/649393/j_sainsbury_ara_2012.pdf Accessed

November 11, 2015

Palepu, K.G., Healy, P.M., Peek, E. (2013) Business Analysis and Valuation (IFRS

Edition), 3rd edn., Hampshire, UK: Cengage Learning EMEA.


Ocado Ltd. (Report Submission)

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