Ocado Group PLC

LSE:OCDO

Earnings Call Transcript 2019-Q1

[Operator]

Hello, and welcome to the Ocado Q1 Analyst Call. [Operator Instructions] And just to remind you, this conference call is being recorded. Today, I am pleased to present David Shriver, Communications Director; and Duncan Tatton-Brown, CFO. Please begin your meeting.

[David M. Shriver, Communications Director]

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

[Duncan Tatton-Brown]

Thank you, David. This has been a very busy start to the year for us with further strong underlying growth in our U.K. Retail business; the launch of our Zoom trial for our new immediacy offering; and of course, the announcement of our transformational joint venture with Marks & Spencer. Our trading performance in Q1 was driven by strong underlying growth in Ocado retail, impacted, as you all know, by the fire at our Andover CFC in early February. We continue to grow average orders per week at an encouraging rate in the double digits, while average order size was only slightly down. The impact of the fire was equivalent to just over 1% of the sales in the quarter. Although Andover represented about 10% of our pre-fire capacity, we were able to mitigate the impact in the quarter by slightly increasing capacity at Erith and smoothing the custom demand across the week so that we could extract additional capacity from Hatfield and Dordon. All our existing customers were able to access the Ocado service, and there were no disruptions to delivery from a geographic perspective. However, post-fire, we were restricted in our ability to meet forward demand and to win new customers. We're working on plans to provide more CFC capacity going forward, which includes setting up a temporary space in Andover and growing our capacity in Erith faster than envisaged. We will give you more detail on these plans in due course and the impact they will have on our target for 10% to 15% growth in retail revenue for the year. I know that many of you are keen to understand what the loss of Andover means for the group financially and operationally. Let me confirm that a thorough examination of the causes is currently being undertaken. So our initial assessment of the reasons for the fire and the draft conclusions from the independent examiner give us confidence that there are no significant implications for the risk profile of the asset or the viability of our model, and therefore, for either Ocado retail or Ocado Group. Turning to Zoom. You will know that we launched our immediacy trial to Ocado customers this month from an initial test site in West London. Although it's only been a few weeks, early indications with respect to demand about these sites are encouraging, and we've received positive feedback from customers on all elements of the service. We will continue to learn more over the coming months as we refine the offering to customers. We believe that Zoom is capable of being a sustainable and profitable solution, significantly increasing the addressable market in the U.K. Zoom is also a concept which is ideally suited for our new partnership with M&S as well as for many of our Ocado Solutions partners. So with that, I'm now happy to take your questions.

[Operator]

[Operator Instructions] The first question is from the line of Vincent Lee from Bernstein.

[Vincent Lee, Retail Analyst]

Just one from me, please. Can you just confirm that you've had to ramp up to full utilization at your mature facilities?

[Duncan Tatton-Brown]

Vincent. Yes, we are running -- in fact, they are running in orders per week at a higher level than they've ever run before because of this comment I made about smoothing of demand in a week. And so we're not able to process more orders on the peak day, and -- but because we are limited in capacity, some of our customers can't get a slot on that peak day, and therefore, they move onto other days of the week where there has historically been less natural demand. So it has the effect of meaning across the week, we get more orders through there, but it also means that some of our customers on the peak day find they can't get a slot with us and will go to a supermarket, which is why we don't do it normally. But it is a way for us to make sure that we satisfy existing demand that we have. And obviously, our aim is to replace the capacity we had in Andover as soon as possible so that we don't need to smooth demand on the week, we can leave it in a natural shape.

[Operator]

Next question is from the line of Andrew Gwynn.

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

Just 2 quick questions, if I can. So I think seasonal impact on Q2 had a bigger seasonal impact or bigger pickup in demand. So presumably, we should expect to see that much more heavily impacted by those capacity constraints. Perhaps there's some early thinking of approximately what that might be. And then, secondly, I think there was a report in the Grocer suggesting that some of the robotic picking technology may have been stored in the CFC3 had been caught in the fire, and that's presumably set back some of the plans. So just wondering if you could confirm that.

[Duncan Tatton-Brown]

Yes, there are plenty of seasonal movements in quarter 2. But overall, the quarter is not a bigger quarter for us than the quarter 1. So there's not, on a week-by-week basis, likely to be a bigger impact in quarter 2. The obvious point, though, is that the fire happened in early February, and so only affected 4 weeks out of the 13 in quarter 1, whereas it will -- the loss of capacity will affect 13 weeks out of 13 in quarter 2. So on a simplistic level, if you take a 1.2% impact and treble that that will give you an underlying impact before anything we can do to replace capacity. On your other point on robotic picking, yes, we have the robot arm, which some of you may have seen on tours of Andover, in the Andover facility. And clearly, with the fire, we have lost that arm. But our computer room and all the data storage and all the software was held in a computer room, which was adjacent to the building and was untouched. So we've lost none of the data, none of the software, none of the learnings, so there's no significant delay. But of course, it may take a few months before we've got to installing a new robot arm in Erith to continue testing and developing that capability in Erith. So it will be some delay, we don't know exactly yet, but some delay.

[Operator]

[Operator Instructions] Next question is from Nick Coulter from Citi.

[Nick Coulter, Director]

Several, if I may. First couple are on the kind of the current trading. So what you just said to Andrew's question, it sounds like there's an exit rate of a high single-digit growth. Would you be able to confirm that, please? And secondly, could I pick up on the work-in-progress plans to provide more capacity at Erith? Could you talk about what that actually involves? Is that physically building picking zones that aren't there and need to be built to improve the capacity? Is that the rate at which you can safely ramp up the bot numbers? It would be great to understand what's allowing you to form a view on the capacity going forward sir, for this year. Those are my first 2.

[Duncan Tatton-Brown]

Yes, I mean, I think in terms of exit rate and going into the quarter, I think I've already sort of talked through the most likely impact, i.e., the 1.2% grow -- across the whole quarter being a bit over 3% impact. There, yes, I don't think there's much more to add on that. In terms of working on plans to provide new capacity, I think an important point to say is it's Erith and anything else that we can do. And the anything else that we can do, we haven't commented on yet. But we are looking at other ways to bring on either temporary or permanent capacity much faster than we normally would have done. That's what we're working on. Those plans aren't finalized, and therefore, I won't comment on them now. But we'll let you know as soon as we've got something to say on that. So in Erith, how do we grow capacity? Unfortunately, there is no single answer to that, it's just trying harder on all the elements, to hire more engineers, put more robots on the grid, to continue to work to improve the reliability. And as you all know, we have our third-generation robot in testing. That's not going to make a material difference this year. It'll be right at the end of this year if we hit the timescale we've planned. So Nick, there isn't sort of a single answer, it's just trying to do more on every angle. So I wouldn't expect a dramatic change in capacity in Erith, it's just how can we squeeze a bit more.

[Nick Coulter, Director]

Okay. Well, that sounds intriguing as to the alternative sources of capacity. Then perhaps a bit further out. There's obviously a lot of warehouses being deployed around the world and another 8, I guess, planned in the U.K. And it's a while since you've talked about CFC economics, so perhaps you'd be able to update on the range of UPH that you might expect from the Andover site warehouse, given that you referred to kind of all of the iterations and the state-of-the-art replacements in your release.

[Duncan Tatton-Brown]

Yes. So Nick, this is all free robotic picking. Andrew obviously raised that question earlier so it excludes any benefit from that. We were targeting to get Andover to 180 UPH.

[Nick Coulter, Director]

Yes. It was at least, wasn't it?

[Duncan Tatton-Brown]

Yes. And then targeting Erith to be at 200. It's worth noting that the week before the fire, Andover was at over 150 UPH, and therefore, was getting quite close even though it's operating at less than half capacity to the levels of efficiency that we were targeting. Erith UPH is getting better all the time. Last week was a new record for Erith in terms of efficiency. So we would expect those numbers to be the types of numbers you would see in future CFCs, again, excluding any benefit we might get from robotic picking we're working on. So no...

[Nick Coulter, Director]

So it sounds like you would expect to do better than that, at least 180 for Andover, given the improvements in the warehouse or no?

[Duncan Tatton-Brown]

Yes. So I wouldn't assume that Andover's 180 and Erith's approaching 200 means that future Andover sizes are at 180. I think they're at 200.

[Nick Coulter, Director]

Okay. And obviously, that -- and are you able to update us at all on operating contribution margin at 200 DDW? I'm just trying to get a sense. Obviously, there's a lot of warehouses out there being built, so it would be great to get a kind of a sense of how the economics are improving.

[Duncan Tatton-Brown]

So Nick, I wouldn't -- I'm not going to spend too long on it now because this is a quarterly trading update. But I think those are good questions, which you should ask again at the half year and we'll have the opportunity to update a bit more then.

[Nick Coulter, Director]

Okay. Perhaps I can just log one for then for the half year, if I may. On immediacy, could you talk about the kind of the capital intensity? Because, obviously, you'll have a CFC and a micro FC. What's your -- and obviously, I know you model these things to death before you put them into trial. So what's the directional sense or of your initial thoughts on the ratio of MHE to sales for something like Zoom? Or what's the mitigating factors which we should think of against that gross capital intensity?

[Duncan Tatton-Brown]

So Nick, as you say, a good question to log for the half year. The model for this concept is approaching the same level of operating contribution with reasonable capital economics. But that doesn't tell you much of about -- we'll consider what more we might say at the half year.

[Nick Coulter, Director]

I'm assuming it's not 2x. It's less than 2x, one would assume.

[Duncan Tatton-Brown]

2x the level of CapEx to sales?

[Nick Coulter, Director]

The MHE to sales, yes. Because, obviously, you have 2 warehouses, I'm just trying to get a sense directly.

[Duncan Tatton-Brown]

Yes, yes, yes. You're not talking about less than half the return on capital.

[Nick Coulter, Director]

Yes. Okay, maybe it's something we can pick up on.

[Duncan Tatton-Brown]

Yes.

[Operator]

Next question is from Sreedhar Mahamkali from Macquarie.

[Sreedhar Mahamkali, Analyst]

Just really 2 short ones for me, please. One, in terms of trying to look for other alternatives to replace the capacity, are you prioritizing not losing sales ahead of any impact on profitability because there may be some options for you to ramp up capacity but will they necessarily be costing you more in the short term, just in terms of trying to understand your priorities for the year at least? A second one, learnings from the Andover incident. What have you changed there because you talk about no significant implications? Clearly, there are some implications. Would like to understand what they are and sort of understand what is giving you confidence that there is no significant implications for the risk profile of that, please.

[Duncan Tatton-Brown]

Yes. Our focus is on maintaining the long-term value in the business, and therefore, it's more around retaining the customers that we've got and, as far as possible, the sales we've got. And I think the performance in the latter part of the quarter shows how resilient our business is, continuing to grow despite the events of the fire. Yes, so our focus is very much on sales. And we obviously have a duty to protect profits as much as possible. But we are insured, and therefore, the insurance policy is there to enable us to maintain the long-term value rather than to worry about this week's profits. We have a good level of coverage from our insurance company. In fact, we've received nearly GBP 30 million worth of insurance payments already to date and we're pretty comprehensively insured. So we're operating the business to try and retain the long-term value of the business, not next week's profits. In terms of learnings, we were pretty clear on the cause of the fire within 24 hours. And we've had an independent examiner looking at it, and they've come up with some draft conclusions and some draft recommendations. But I have to say that they're drafts, and therefore, we're not going to go through them now until they're final because I don't think it's in anybody's interest not to share them until it's finalized. That's why we're confident that the changes are minor and there are no significant implications. And once this is final, then we can talk more about it, and you should expect us to say some more about it later in the year.

[Operator]

And there are currently no other questions registered, so I will hand the call back to the speakers. Please go ahead.

[Timothy Steiner, CEO & Executive Director]

Well, thank you, ladies and gentlemen. That concludes our Q1 Trading Call. We'll meet again formally at the first half results on the 9th of July, but we hope to see and speak to most of you before then. Thanks. Bye for now, and have a good day.

[Operator]

This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.