Ocado Group PLC

LSE:OCDO

Earnings Call Transcript 2018-Q1

[Operator]

Hello, and welcome to the Ocado Group trading update call. [Operator Instructions] And just to remind you, this call is being recorded today. And I'm pleased to present David Shriver, Director of Communications; and Duncan Tatton-Brown, CFO. Please begin.

[David M. Shriver, Communications Director]

Thank you, and good morning, everyone. Welcome to the first quarter trading update analyst call. Our Chief Financial Officer, Duncan Tatton-Brown, will give you a summary of our progress in Q1, and then we will go to questions. Duncan, over to you.

[Duncan Tatton-Brown]

Thank you, David, and good morning, everyone. We're pleased to report another quarter of strong underlying sales growth in our Retail business in line with the guidance for the year. For the first 12 weeks of the quarter, we performed well, having resumed growth in the 12% to 13% range, following the resolution of the driver shortages we experienced in quarter 4 last year. Good progress was made in improving volumes through our state-of-the-art facility at Andover, CFC3. Last week, we did nearly 25,000 orders from Andover, representing another significant step forward, as we grow capacity in this revolutionary new facility. While CFC3 has given us additional headroom, we've been operating for most of the quarter at maximum capacity and, thus, have grown as fast as we're able ahead of opening CFC4, which we expect as planned this summer. The last week of the quarter, however, was impacted significantly by the Beast from the East when we saw a big drop in the number of orders fulfilled, tens of thousands equivalent to nearly 1% of our sales over 13 weeks. Because we were ready for such unusual winter weather, we deliberately held back slots, and we amended our algorithms to allow the slower-rate speeds, and so fewer drops for Lat Am. This accounted for around half of the drop in orders. The other half was caused by a combination of orders canceled on the road, that is deliveries that we tried to make, but couldn't get through; and orders we had to cancel because some of the spread sites were cut off. Bristol, Oxford and Kent were the most badly affected areas. Notwithstanding the very unusual weather and challenging conditions, we nonetheless were able to deliver 296,000 orders, and we're very thankful for our colleagues for their exceptional work on behalf of our customers. Although this is a trading update, I should also point out that because of the bad weather, we had more vans and more drivers to do the same volumes. And of course, our shrinkage went up. All of this meant a hit of around GBP 1.5 million to budget that week. As a result of the weather issues in week 13, the reported rates of retail revenue growth over the quarter was broadly the same as Q4 2017 at 11.7%. Overall, we're pleased with our progress in the quarter. Both our Retail and Solutions businesses are taking advantage of substantial growth opportunities. And the teams are hard at work, and the group is firmly looking forward. I'm now happy to take your questions.

[Operator]

[Operator Instructions] We will now go to the line of Tim (sic) [ Tom ] Wharram at Bernstein.

[Thomas Wharram]

All right. Sorry about that. My line briefly cut out there. First of all, can I ask, on the capacity question, you said you were approaching maximum capacity for most of the quarter. Is that just in that final week when you weren't at capacity? Or was that for other bits of the quarter as well that you weren't at full capacity? Can I also ask, just on the Erith opening, is it mid '18? I've seen that calendar mid '18, so we won't see any impact of not capitalizing costs during H1? And then thirdly, on the basket size, I have gotten the impression that the impact of Smart Pass reducing the order side and have been reducing -- we've now got more inflation coming through, and the basket size is now coming down again. So is that the impact of Smart Pass? And if so, why is that increasing?

[Duncan Tatton-Brown]

It's Tom, isn't it, actually? Not Tim?

[Thomas Wharram]

That's right, yes.

[Duncan Tatton-Brown]

Yes, yes. Tom, capacity, if we say for most of the quarter, we're operating at maximum capacity. We have quite a consistent profile across the year. And events like half terms or other seasonal events are quite predictable year-on-year, but not -- the profile is that not every week are we operating at full capacity. So in the first quarter, given the fact that we have the buildup to Christmas, and then the Christmas week, we're operating at full capacity for most of it, but not every single week. So yes, week 13 was one example. There were a few others, but most of the quarter operating at full capacity. In terms of opening for Erith, yes, mid '18 as planned. Mid '18, we weren't too specific about whether it's calendar or financial, although they're pretty close. But Tom, I think you're right to assume that there shouldn't be much impact from the fixed cost of Erith in the first half results, because even if it was upward slightly before the end of the half, it will be immaterial. In terms of basket size, continued -- yes, continued utilization of our service by customers, who use Smart Pass. Good growth in new customers with slightly smaller basket size also contributes, and then some underlying inflation. And I think I'm sure there'll be questions on inflation. So just to -- as to perhaps address that straight-up, we are seeing inflation. We continue to track both the market leader with our basket-matching scheme and our supply partner on those products that have the same brand name. And therefore, we see a combination of those effects. There's been no change in strategy for us in the quarter. So we're seeing some modest inflation and some slight reduction in basket size.

[Operator]

Our next question is over to the line of Andrew Porteous of HSBC.

[Andrew Ian Porteous, Analyst, European Retail]

So a quick one. Just on the driver shortage, I appreciate you've sort of sold out for the moment as -- but it seems like your capacity isn't really increasing that much at the moment. That probably accelerates later in the year. I was just wondering if you had any sort of feel on how recruitment of drivers would've been later in the year, and whether you're planning anything to help with that?

[Duncan Tatton-Brown]

Andrew, yes, I mean, I think the driver shortage was a problem for us at the beginning of the fourth quarter last year, and we are planning for that challenge again this year. Just to help understand, given our profile of sales across the year, when our customers are taking their summer holiday, our volumes are slightly lower. And therefore, we have -- as it were. We don't have a requirement for additional drivers. When people come back from their holiday, and the winter's starting to pour in, demand for our service goes up. So every year, a particular pinch point is that autumn ramp. So clearly, we know that, and we will try and mitigate that. So I don't think across the year, overall, we should expect to see any significant driver shortages, but there will be weeks where we will probably hire a lot of people, particularly because we're a growing company and doing quite well. And we're also, of course, serving Morrisons' business, which has been growing strongly as well. So we're planning ahead. We don't expect that to create a problem for us, but it's not going to be easy because we're a growing company.

[Andrew Ian Porteous, Analyst, European Retail]

It's fair to say that the capacity additions this year in Q4 will be much greater than they were in the year just gone?

[Duncan Tatton-Brown]

Well, we've given you an indication of what we expect our revenue to grow this year. So clearly, it's going to be within that expectation. Do I think that CFC capacity will be slightly less of a constraint in the fourth quarter? Hopefully, yes, which is -- because we're opening Erith in the middle of the year. So yes, we might put ourselves under a little bit more challenge, but we're aware of that.

[Operator]

Our next question is to the line of Andrew Gwynn at Exane.

[Andrew Philip Gwynn, Senior Food Researcher & Analyst of Food Retail]

Two for me. So the first one, just could we explore that slight dip in the value of basket? Obviously, you mentioned some of the inflationary questions out there, but obviously, it looks like the volume is down slightly on the basket or maybe mix. And then the second question is just on the consensus. I think you have compiled it quite recently. I'm sure you're going to say something along the lines of, if we had anything to say about consensus, we would say it, but I suppose just to hear it from the horse's mouth, as you will?

[Duncan Tatton-Brown]

Andrew, on the basket, I don't have much to answer what I said before. So we are seeing modest inflation, and we continue to track market leader and our supply partner. I think everybody's fully aware of the performance of our supply partner, who reported their full year results last week. And they talk about margin and price pressures in their product, so we're clearly selling that. So we've seen some of that and, therefore, that will have an effect on our basket. We continue to see growth in Smart Pass and, we continue to add new customers. So those have an impact on basket. Outside of that, I don't think there's anything particularly strange to comment on. On consensus, yes, we published the consensus a day or 2 ago. So that's an updated consensus. The only thing, Andrew, I would just say, is I did mention in my introductory remarks the effect of the Beast from the East in week 13. And clearly, they're running at capacity constraints for a lot of the time. You don't have much chance to make that up. So there's a little hint about a very modest change there.

[Andrew Philip Gwynn, Senior Food Researcher & Analyst of Food Retail]

Just on the consensus, do you think that people have accurately reflected what Waitrose has been saying that will happen to that margin?

[Duncan Tatton-Brown]

Yes. So apart from the week 13 comment, Andrew, I don't think there's another stair. I don't think there's anything in this release which says there's another stair. So I'm not going to say something that's not in the release.

[Operator]

We'll now go to the line of James Tracey at Redburn.

[James Tracey, Research Analyst]

Two questions for me. The first question is, you mentioned that the 12% sales growth was strong underlying sales growth. You should get back to the idea you're talking about 20% to 30% sales CAGR. So how's your view on the long-term growth as the U.K. online grocery market changed, the fact that the 12% is a strong performance? And then the second question is on inflation. Can you give us an indication of how that evolved throughout the quarter and what your view is on inflation going forward?

[Duncan Tatton-Brown]

James, yes, I do think that 12% is strong. And you look at the rest of the industry and all the players, and I think that is -- it is very strong. And unfortunately, we're not going to be able to talk that much at the moment, because if we're effectively operating at a capacity constraint, we can't grow much faster than we're growing now. So when we have additional capacity and the ability to grow, then we can -- then you can ask us that question again to see whether we're able to grow faster than we're currently growing. But our issue at the moment is our capacity. Our platform over the last 5 years has grown compound at 20%. So we see no concerns about the ability for channel shift to continue to happen. We still see that coming. In terms of inflation, nothing particular to comment throughout the quarter. So there's no particular trend to draw on, apart from nothing particular specific.

[James Tracey, Research Analyst]

Can I just follow up on that question on the capacity -- that point on the capacity constraints? If CFC3 has been opened for almost a year now, I think, so what specifically is the issue there? Can you not put more volume through that than what you've got already?

[Duncan Tatton-Brown]

James, we can, and we are. And I think we talked about around 5,000 orders pre to summer. A quarter later, we talked about modeling to about 10,000. A quarter later, we were at 15,000. Less than a quarter later, we're at 20,000; and then at 6 weeks later close to 25,000. So we're very happy with the progress. We are ramping. But the 5,000 orders per week, when you're at 300,000 pace, and you're growing at 12%, it means you need all of it and more. So yes, we are at capacity constraint, but we're very pleased with the progress on Andover. And we look forward to the opening of Erith in midyear. So...

[Operator]

Before we go to our next question with Xavier Le Mené at Bank of Merrill Lynch [Operator Instructions]

[Xavier Le Mené]

Only one. Can you just tell us about the -- your loyal customers and potentially the number of spot pilots you have, and how that's been increasing over recent months?

[Duncan Tatton-Brown]

Xavier, there is not much more detail I can provide. I think the proportion of our customers' orders that are using Smart Passes has continued to grow modestly. I wouldn't say it's dramatically fold, but has continued to trend. The behavior of those customers is very much as we like. And I think we can update a little bit more at the half year when we'll talk perhaps more about customer behavior. But no, there's no particular point to pull out today.

[Operator]

We have a final question from the line of Nick Coulter at Citi.

[Nick Coulter, Director]

So 3 for me, please. I know it's not a sales call, but is there anything that you would call out with regards to gross marginal competitive environment moving from Q4 to Q1? And obviously, notwithstanding Waitrose's comments around their gross margin under pressure with the year just gone, but is there anything new that we should take account of? And secondly, obviously, it's still very early days, so are you able to talk to some of the operating stats for Andover like outbound pick grades or inbound decants? So I guess, is it the UPH figures won't be meaningful at this stage with the overhead drag? And then lastly, are you able to talk about your plans to nonfeed or GM at Erith? Will that be past the ambient grade? Will that be a separate pick of bulky highs? We'll be interested now to hear your approach as your plans come to fruition.

[Duncan Tatton-Brown]

Thanks for your questions, Nick. In terms of margin, Nick, I won't make any comments. There's nothing in the release, so I don't want to start adding too much to the release. But there's no comment. It doesn't mean that we're hiding something. I just think there's literally no comment to make. So there's nothing significant going on there. From UPH, we won't be disclosing UPH for Andover at the half year, but what I can say is that UPH is getting better, as Andover is actually ahead of our expectations at the moment as we're ramping the facility. So things are progressing very much as we would want, and it is getting better. But by the way, it is still lower than in our mature facilities at this stage. On nonfood, we haven't formally commented on it before, Nick, but it's no harm showing this now. Actually, we're opening a second general merchandise facility, which will be located near Erith. So we're not putting it in Erith. And effectively, that comes back to a capacity constraint, both for the physical capacity of the Erith facility, but also our capacity to develop code quickly enough for use of that facility for multiple categories at the same time as trying to develop code to enable us to put CFCs in Paris, in Toronto and elsewhere as well. So there's a prioritization decision there from a technology resource capacity and a physical capacity. That means that we're building a separate facility. The solution would cope with it, but we're not going to do it yet.

[Nick Coulter, Director]

That's interesting. But just to come back on the growth margin, it sounds like there's nothing to call out moving from quarter-to-quarter in terms of gross margin now. That's my interpretation. I realized your guide is in terms of what you can say. But if there's nothing to add, that, by default, must be the conclusion. I just wanted to check.

[Duncan Tatton-Brown]

Yes. You're right to conclude that. With one very small additional comment, a flag at GBP 1.5 million missed a budget in week 13, which is partly sales, but obviously partly shrinkage. We have a lot of food that we unfortunately couldn't deliver to our customers because of the weather conditions. By the way, that food ended up in charities and food banks, and there was lots of meals for people who were probably suffering in quite difficult weather conditions. So it didn't go to waste, but it was a margin impact. But it's only one week, so it's relatively modest.

[Operator]

As that was the final question, could I please pass it back to you for any closing comments at this stage?

[Duncan Tatton-Brown]

Very well, thank you very much, ladies and gentlemen. That concludes our Q1 trading call. We will meet again formally at the first half results on the 10th of July, but we hope to see and speak to most of you before then. Thanks, and bye for now.

[Operator]

This now concludes the call. Thank you all very much for attending, and you can now disconnect your line.