Robots may not yet be ready to take over the world, but they are certainly making inroads with the warehouse picking and packing business – notably as online grocery store Ocado (LSE: OCDO) continues to transform itself into a provider of automated warehouses for retailers.
Through its technology arm, Ocado Solutions, it has already struck international deals with firms like Sweden’s ICA Group, France’s Groupe Casino, and Kroger in the US. Last week, it announced it would be doing likewise for Japan’s largest supermarket chain, Aeon.
Times are changing
The shift in focus towards automatic warehouse solutions offers Ocado a lot of opportunity and diversification. While its grocery business is coming under more pressure from competition online, almost by accident Ocado has discovered that the robotic facilities it set up for itself is, in many ways, an even greater asset to sell.
The reasoning behind this growing popularity is obvious – automatic warehouses are far cheaper to run. They are also generally more efficient, robots not needing lunch breaks and being ‘happier’ to work long hours at any time of day. Not to mention they do not require employee benefits and pensions.
Ocado also has the advantage of a proven model and structure that has worked for the company itself for years. It is one thing for a firm to know in theory that having an automated warehouse will be cheaper, but another entirely for it to actually implement it without ever having seen it work in real life.
Money in, money out
These tie-up deals with other retailers offer Ocado a lot of earnings potential. Taking the latest Aeon deal as an example, Ocado will receive both up-front and ongoing fees based on a number of factors, most notably sales. It also offers the firm access to Japan’s £35bn online grocery market. Ocado and Aeon plan to build a national network in the country with sales potential of ¥1tn.
However, this does not come without costs. In general, the client plays for the shell of the warehouse and delivery vehicles, while Ocado finances the robotics and software roll-out. These costs and with them, the news that Ocado will be launching £500m in convertible bonds, are the rub for investors.
Though the expected coupon of between 0.75% and 1.25% is a fairly modest price to pay for debt in the corporate bond sector, the fact it is convertible to equity means there is potential for dilution of shares. Admittedly it is still a better option than raising money through a share issuance directly, but with the conversion offering an expected 45% premium to the current share price, it is likely that a number of bondholders will eventually convert to stock.
Overall, I think the move and diversification into robotic warehouses is a good one for Ocado that offers a competitive advantage when trying to form deals with other companies. I think it is a fairly niche market which the company’s already established facilities prove can work.
In the near term, however, the increased capital expenditure, and now the issuance of the convertible bond, with its potential for dilution, means I will be happy to wait on the sidelines before committing my money to Ocado shares.
