Sales are up, but the road to profits is not going to be easy.
I was far from alone in my scepticism of the originally mooted flotation price of Ocado (LSE: OCDO) shares, when the company planned to come to market in July. The price of 200-275p was an outrageous overvaluation, as many commentators pointed out, and few were surprised when it was subsequently slashed to just 180p -- at the higher price, they simply would not have been able to unload enough shares.
Maiden figures
I, along with many others, still thought that was too hefty a price tag, and the shares have subsequently slid from that opening 180p to 142p today. The price had recovered a little in advance of Tuesday's interim management statement, representing Ocado's first figures as a public company, but it rapidly fell back once they were out. Those who bought at the float are 20% down in less than two months.
So what was in the results that generated such an unimpressed reaction?
Well, on the face of it, we saw percentage growth figures that many a company would be proud to report, with gross sales for the 12 weeks to 8 August 8 up 30% over the same period last year, and the 36-week growth figure up by the same percentage. In the last quarter, Ocado sold groceries to the tune of £126.5m.
The average order size remained much the same, at approximately £114, but the number of orders per week rose to 92,800 for the quarter, from 71,000 in the same period last year. Turning to the company's cash situation, it had cash and equivalents of £206m at the end of the quarter, with borrowings of £120m, but available credit facilities of £110m.
When it came to profits though, there was next to no information at all.
Award
At the Grocer Gold Awards 2010, Ocado was awarded the coveted title of "Online Retailer of the Year", though it has to be said that in the grocery business there isn't all that much competition -- and to put things into some perspective, Ocado's main competitor, Tesco (LSE: TSCO), shifted more than £2bn via its online business in its last full year, making a profit of £136m.
So, sales up 30%, and plenty of cash in the bank -- that would be a healthy situation for a profitable and mature company. But Ocado is still searching for its first profit, which is expected to come in 2011, and came to market partly to raise money for expansion in order to achieve that goal.
So what of that expansion? Well, we are told that potential sites for the company's second main warehouse, together with "spoke" warehouses (smaller ones used for distribution) have been identified. But even after that is up and running, reaching a sufficient profit to justify Ocado's current market capitalization will be tough.
Capacity
As one Foolish observer commented at flotation time, the first warehouse was running at around 80% capacity back then, suggesting a maximum turnover of around £525m and making the possibility of running the warehouse at a profit quite slim. However, in its flotation prospectus, Ocado told us that part of its plan is to raise the capacity of its current warehouse initially to around 150,000 orders per week, and possibly 180,000 later. Overheads won't rise proportionately, so that should be a comfortably profitable size.
If the second warehouse can be built and expanded to around the same capacity (it's expected to start off at around 120,000 orders per week), and if sales can be grown to utilise it fully, then we could be looking at a capacity for turnover approaching Tesco's current annual £2bn online mark. But it's taken Tesco ten years to get that far, and Tesco's brand has a far greater share of shoppers' mind space, so it will be a tough challenge.
Valuation
Ocado's current price to sales ratio is around the 1.5 times mark, based on estimated revenues for 2010, while Tesco's is little more than 0.5 times, which is about typical for such a low-margin business, And that means a lot of Ocado's planned expansion is already factored into today's share price.
And what adds to the risk is that it is hard to see how Ocado could reach the kind of sales figures it would need in order to justify its current valuation, without having to seek new funding -- as the flotation prospectus did recognise. All that talk of increasing capacity sounds great, but doing it with the cash it has in the bank will be, erm, challenging, to use today's favourite accounts-speak phrase.
Would I buy the shares now? Not a chance.
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