Ocado Group PLC

LSE:OCDO

Earnings Call Transcript 2021-Q1

[Operator]

Hello, and welcome to the Ocado Q1 analyst update. I will shortly be handing you over to Tim Steiner, Niall McBride and David Shriver, who will take you through today's presentation. There will be an opportunity for Q&A later in the call.For now, over to Tim, Niall and David of Ocado.

[David M. Shriver, Communications Director]

Thanks, Charlie, and good morning, everyone. This is David Shriver, Communications Director of Ocado Group. Welcome to the first quarter trading update for Ocado Retail, which, as you all know, is a 50-50 joint venture between Ocado Group and M&S.I'm joined today by Tim Steiner, Chief Executive Officer of Ocado Group and Chairman of Ocado Retail; and Niall McBride, the Chief Financial Officer of Ocado Retail. Now we'll begin by reviewing the highlights of the quarter and then hand over to Tim, who will put the numbers in a broader context and share some perspectives on the current year. We'll then go to questions.

[Niall McBride]

Thanks, David. Ocado Retail has had another very strong quarter of growth with sales growing 40%, reflecting strong demand for online grocery and the continuation of a smooth trading week. This, of course, compares to a largely pre-COVID period last year. Average order size of GBP 147 reflects seasonal strength over the festive period and a temporary reversal of the trend towards normalized shopping behavior in response to further national lockdown measures in the U.K. Progress in orders per week reflects underlying trends in basket size. Erith CFC capacity serving Ocado Retail, ending the period at 150,000 orders per week. We will be adding significantly to our capacity in FY '21, with Bristol now opened, and Andover and Purfleet coming in the fourth quarter. This will give us the opportunity to provide more slots to existing customers and bring new customers onto the Ocado platform.I thought it would be useful to share a few reflections on the business as we're a year on from when the U.K. first went into lockdown. It is difficult to encapsulate how far the business has come in the past year. Of course, we've brought on M&S and eked out as much capacity as we can to meet demand. But importantly, I think we've demonstrated the operational resilience of the business, and we're very proud of the service we've delivered over the past 12 months. We've also provided a window into the economics that the model can deliver at scale. The bit that is perhaps less obvious from the [ update ] with a huge amount of work that has been done behind the scenes to set us up for success as we look forward, the improvements in our IT infrastructure, the benefits we are seeing of having established our own buying operation, reinvigorating the branding, opening new capacity in Bristol, refining Zoom and the many, many upgrades to the service proposition. Ocado Retail has taken a big leap forward this year, and this business is much stronger than it was a year ago.Now we cannot precisely predict how the demand environment will evolve in 2021. But what we do know is that we've proven the strength of the model as well as the customer proposition this year, and we're looking forward to the future with confidence.And with that, I'll pass to Tim.

[Timothy Steiner, CEO & Executive Director]

Thanks, Niall. Q1, of course, annualizes against a pre-lockdown period last year and, therefore, is still recording very strong growth. However, even as we progress through FY '21 and the year-on-year comparisons become more challenging, we do not expect that we will go back to the way things were pre-COVID.The landscape for grocery retailing in the U.K. and in many countries around the world is changing for good. Large numbers of customers who tried online grocery for the first time, for the most part, they see its benefit and won't be going back. The dramatic growth we've seen in online grocery market share over the last 12 months more than doubling to around 15% of the U.K. market represents an acceleration of a long-established trend. Channel shift is not a new phenomena. It is not something caused by COVID, which will go away when COVID is over. Quite the contrary.We are confident that going forward, we will report strong growth and market share gains once we work through the distortions caused by a challenging year-on-year comparisons. There are 3 reasons for this. First, Ocado Retail offers the best consumer experience in terms of range, freshness, price, low substitutions and high rates of on-time delivery. The more customers become familiar with the benefits of online grocery shopping, the more Ocado will benefit. Second, we are highly confident that we -- as we add capacity, we will quickly utilize it. To put this in context, we are currently registering more customers every week than we can serve, and that rate has accelerated since we launched Marks & Spencers. Thirdly, we are building a lot of capacity to enable us to welcome a lot more customers to Ocado Retail.Our first mini CFC in Bristol opened at the end of February. This is an important part of the flexible Ocado Smart Platform ecosystem available for all our partners and provides a very welcomed additional 30,000 orders per week. We have 2 more standard sized CFCs opening around the start of the fourth quarter in Andover and Purfleet with 60,000 and 85,000 orders per week, respectively. Altogether, the sites we are opening this year, when at maturity, will bring 40% more peak day capacity to the business.Beyond that, we have another mini in [ Vista ] opening in 2022, and we are making progress in securing the sites for CFCs 8, 9 and 10. At the same time, we are also looking to open more than a dozen Ocado Zoom sites in London as we bring a 1-hour from ordering immediacy service to many more customers.What this all means is that Ocado Retail is primed for growth. The Ocado model, which our partners today are beginning to roll out, has demonstrated its robustness and strong operational gearing through the crisis. And we are looking to build it as fast as possible, taking advantage of Ocado's proprietary technology and the benefits of a platform, which allow us to meet the whole range of customer shopping missions. We are confident for the future.Operator, back to you.

[Operator]

[Operator Instructions] Our first question is from the line of Andrew Porteous from HSBC.

[Andrew Ian Porteous, Analyst, European Retail]

I guess, the sort of new information from my side today seems to be around the sort of the micro fulfillment that you're -- or the immediacy solutions that you're rolling out in the 12 sites in London. I just wonder whether if you could give us a bit of sort of context for that decision. Has that been accelerated in the context of what some of the food delivery companies are doing in grocery? Or is it more planned within the business, given what you've seen in the existing Ocado Zoom sites?

[Timothy Steiner, CEO & Executive Director]

So Andrew, I'd say it's more on the plan side. We -- as you know, we rolled out the first Zoom site a couple of years ago. We've been trading it. We've been in the market looking for more sites. We've got plans to grow in that sector. I think it's always worth remembering that 12 new sites is half our warehousing capacity. So I think you've got to put them into context. But we see opportunity for more Zoom sites in London and some other cities. And so just because we get asked a lot of questions on this, we wanted to clarify that we're looking for at least a dozen sites in London to roll Zoom out, too.

[Andrew Ian Porteous, Analyst, European Retail]

And then just in terms of capacity, could you give us an idea on the sort of shape of capacity through this year? I mean, it feels like given what's going out to Morrisons, Q2, Q3 could be a little bit stickier and then you get a bit of relief in Q4. Is that the way to think about it?

[Timothy Steiner, CEO & Executive Director]

Well, then it's certainly right that, yes, we opened Bristol, which is the smallest of the 3 new warehouses coming on stream this year. We've obviously continued to ramp up in Erith, but now some of that volume is now -- the future growth in Erith at the moment is going to Morrisons. Bristol will continue to ramp fast, and we said that we can ramp it from 0% to 100% in the space of a year. And then at the start of Q4, we'll get the 2 new additional warehouses, which can then ramp over the following 12 to 18 months. So yes, in terms of the comparisons, Q2 and, in particular, Q3, are the toughest comps to come up against. And then in Q4, we've got more additional new capacity. That's correct.

[Operator]

Our next question is from the line of [ Michael Levitz ], independent analyst.

[Unknown Analyst]

Yes. I'm very intrigued by your call, actually. You have not been brutally honest about your systems and processes. An actual fact, Kroger and the others, your shareholders, have also said this and also Morrisons, it seems that they're actually not really doing a lot of business with you at the moment, and your systems cannot cope, and you've actually breached PCI DSS 2.0 by holding cardholder details. And you're claiming this pre-COVID pandemic and afterwards, but you can't actually cope because your [indiscernible] said as well that you can't get any stock in. And then all of a sudden, [indiscernible] leads and all these stories, your Ocado Zoom service doesn't work very well from what I know and from people who've used it. And large amounts of customers had orders can't sold. And you've also not spoken about the patent infringement, which you're being sued for between the 2 of you. And you've also not spoken about your systems and how you breached the Equality and Human Rights Commission's policy for lockdown by prioritizing [ Sarah Vine ] and plenty of other analysts who spend regularly, who are on the shielded list, and your behavior towards them. So I would like some color on that.And also, when are you ending the relationship with Morrisons? Because as everyone knows, they're not going to be doing much more business with you for the future. And if Mr. Steiner would like to answer, in 2017, I asked him when the deal with M&S is coming through, and he said there was no deal. So would you like to give some honesty? And also, the robots and the warehouses and the fires are not foolproof, and it's not true what he said. So if you'd like to give some color on to that, I'd be very happy to hear it.

[Timothy Steiner, CEO & Executive Director]

Michael, thanks for that. Obviously, we disagree with pretty much everything you've just said. [indiscernible] Michael, thank you. [indiscernible]

[Unknown Analyst]

Well, legally, you're in a [indiscernible]. You held cardholder details [indiscernible] but to the breach and the [indiscernible] have already [indiscernible] fraud that has happened due to Ocado systems crashing and the temps on your website. And you have not been honest, Mr. Steiner, and you've been contacted. And legally, you know full well the position that you should have released the statements to the SEC as well. And [ Dane Melany ] as well has been far from honest...

[Timothy Steiner, CEO & Executive Director]

Operator, let's go to the next question. Thank you. Operator? Thank you.

[Operator]

Our next question is from the line of Nick Coulter from Citi.

[Nick Coulter, Director]

Nick Coulter from Citi. So 3, if I may, please. I'll go one by one for ease and clarity. Firstly, could you give a sense of what sort of normalized capacity increase we should expect at Erith each quarter as it continues to ramp? It looks like it was a short 20,000 in the last quarter. And then just to clarify your comments to Andrew, should we expect you to be capacity constrained across Q2, Q3? Or how should we think about your management of that capacity profile? That would be the first one.

[Timothy Steiner, CEO & Executive Director]

Nick, from a capacity perspective, so yes, look, we're continuing in particular to grow Bristol in Q2, Q3. In Q4, we'll have on stream Andover and Purfleet, as we said, so we'll get more growth into Q4. In terms of at the moment, we are capacity constrained every day. Now obviously, we don't know how the positive COVID conditions continue and whether we return to some shape of week or whether we maintain a flat week. And also, we don't know whether the seasonal trading pattern that we historically had that we didn't have last year when the large number of customers go away in July and August will come back and be present in Q3. So I think the comp is hardest in Q3. Q2 is -- there's growth in Q2, and then Q4 is the easiest one, where we can have the most growth year-on-year.

[Nick Coulter, Director]

Got it. And then with respect to Zoom, are you able to kind of fast-track it, any sites, by using spokes? Or is this just purely a game of patients rather frustratingly around planning? And then, I guess, it sounds like you're making progress. But how long do you think it will be before you have a commercial proposition to Zoom that the solutions business can market?

[Timothy Steiner, CEO & Executive Director]

So Nick, thanks. We've got a commercial proposition that we can market now. So we're talking through a number of our international clients as well as Ocado Retail about building Zoom sites. And the critical thing for us is to build sites that are scalable, that offer long-term estimate, positive economics, both for the client, in this case, Ocado Retail, but also for the Ocado Group in terms of provision of the service. So we want to go out there and help our clients to go out there with the best immediacy proposition.So with broader ranges, over 10,000, 12,000, 15,000 type size ranges with only a requirement to have small price increase over the hypermarket and to deliver in an hour, and to be able to do that in a sustainable profitable way, that does require automation. And therefore, it is a game of finding sites that are of the right size, in the right location. Because the key with immediacy, of course, is that you've got to do all of your deliveries in a tight radius, something like a 5-kilometer radius. So you can't -- there are a number of sites that you can find where they're physically constrained on one side, and then you've only got the radius kind of in one direction. And from that, you won't gain enough volume to get the throughput. So it's not the easiest game to find the right sites, but we are out there. We're actively looking. And we are finding some, and we'd like to obviously find more.

[Nick Coulter, Director]

Okay. Then a last geeky one perhaps for Niall on your promotional strategy [ or your route ]. The data suggests you're going a little deeper on your discount rate. M&S looks to be traveling in the same direction, but you looked to be doing a bit more. And obviously, without placing too much reliance on the data, it would be good to hear your thoughts.

[Niall McBride]

I'm not quite sure what the data is that you're there on. But I think, look, we're constantly looking for ways to give our customers great value for money. And that's why we've launched the value delivery range, clearly marks out the sort of low-priced product, making it easier and transparent for customers to shop that and without the need to wait for a voucher. And we've also -- this week, we launched our own label, again, to give customers more choice at various points. But...

[Nick Coulter, Director]

But just as the data suggests, you're going a bit heavier on promotions but just narrowly and deeply, but that might be a false read.

[Niall McBride]

Yes. No. I mean, we're constantly making sure we've got the right level of promotions on. I'm not sure there's been any -- well, there hasn't been any great change of strategy there.

[Operator]

Our next question is from the line of Fabienne Caron from Kepler.

[Fabienne Caron, Head of Food Retail Sector]

Three quick questions on Zoom, if I may. The first one, could you share with us for a standard Zoom what's the order per week and the basket size?The second would be for the 12 micro Zooms that you're looking at, do you have an idea of the timeframe?And last one, interestingly, you said that your international partner are looking at Zoom. Would you be in a position to share with us if we should expect, for example, the first Zoom to open in the U.S. because it's quite a lot of micro fulfillment center over there? And would you be in a position to build the Zoom in the back of the store if your partner would require you to do so?

[Timothy Steiner, CEO & Executive Director]

Yes, sure. Look, Zoom sites are GBP 15 million to GBP 25 million in annualized sales capacity. That's kind of the optimum size. We predict Zoom orders are something like 35% to 45% of the size of a full basket order. So in our own Zoom site in West London, the basket was in that range pre-COVID and the basket rose as the basket in the main shop as well.The -- in terms of the timing on the locations, look, we'd open them up as fast as we find the locations. But right now, I would expect that we'll open something half or something of the desired sites in London in the next 24 months, something like that, that would be a good target to open or at least to be in construction in that many of the sites. In terms of international, I can't speak about specific international commitments with our clients until they make commitments and we announced those or they choose to announce those commitments. But I would expect to see some of our clients add Zooms to their network.And then in terms of back of store, look, if there's the right space with the -- if the building is appropriate, then the client can put it in the back or on the corner of the store. That is all possible. I think it's just always worth remembering that Zoom is the right -- a micro site is the right asset to serve immediacy orders, smaller baskets, short delivery times at a price premium that is likely between the percentage delivery fee and the price on the goods i.e. whether it's to do with promotions or the range or the actual pricing. It's something like an 8 to 12 point cost, a higher cost, similar to a convenience store in the U.K. compared to a hypermarket. And so, obviously, the stores where this will make sense are stores in very densely populated areas. Micro sites are not an alternative to the large sites that most cheaply fulfill full baskets.

[Operator]

Our next question is from the line of Andrew Gwynn from Exane BNP Paribas.

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

Two questions, if I can. So first question, just coming back to the capacity. Is there an argument to say that you should really, really ramp up capacity now? I mean, obviously, you've had a year or so of being pretty heavily capacity constrained. I appreciate, obviously, you've got the capacity coming down the pipes for the end of this year. But clearly, if the order list and the customer list is as long as you suggested, then there is an argument to say you should be opening tens of CFCs in the next 5 years or something. So I suppose why are they still relatively pedestrian in the state if we're in a position where channel shift really, really is accelerating? So that's the first question.Second one, maybe just goes back to sort of classic U.K. corporate broking language. But can you just decode the comments around profitability? I suppose the very simple question is, are you happy with consensus?

[Timothy Steiner, CEO & Executive Director]

Okay. So why don't we do tens of sites? Look, we're out there looking for 3 large sites, 12 micro sites. And we have, since we last spoke, announced another mini site in [ Vista ]. So we are out trying to add capacity. Should we be looking for more than that? I mean, it's no point making that decision until we can find those sites anyway and monitor the ongoing trends. But we are looking to substantially increase capacity. So the sites opening this year add about 40%, and we're looking for more sites. The site even out that we're looking for, in total, are more than we are adding this year. So you're talking about adding more than 100% of capacity to the current business between the sites opening this year and the sites that we've announced that we're looking for.

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

And so the 3 CFCs, are those standard-sized, sorry?

[Timothy Steiner, CEO & Executive Director]

We're looking largely for standard-sized CFCs on top of the mini CFC. We just opened a mini CFC and 2 standard-sized CFCs. So if you add that all together, it's 100% growth capacity that we're adding. And so that -- could we be looking for more than that? We could. And obviously, as that starts to come up, as we find those sites, we're going to continue looking. We're not -- we've not said we're going to do that, and then we're going to pause for 3 years. That's not the point. The point just is those are the ones that were out in the market looking for locations that we'd love to sign up as quickly as we could find the appropriate ones.The -- look, everybody successfully kind of backed out the profitability in the second half of -- for Ocado Retail in the second half of last year. The first quarter has been a continuation of that -- largely been a continuation of that type of trend in terms of basket size, flat week, margins, et cetera. So we've actually had some greater positive tailwinds, but we've also had some opening up costs relating to the new site in Bristol, just to temper that a little bit. So yes, the first quarter has been profitable, more or less in line with the second half last year and ahead of consensus. But we're not looking to dramatically move consensus because, obviously, we need to wait and see what the trading conditions are for the remaining 3 quarters of the year. And as the vaccination program successfully continues to roll out and lockdown is eased, we would expect to see some normalization of basket, some shape of week possibly coming back in, and therefore, some of the positive tailwinds marginally unwind.Niall, do you want to add anything to that?

[Niall McBride]

No, I think you've covered it. Q1 is the last period where we're obviously lapping a non-COVID period. So the outlook for the rest of the year is dependent on the factors that you've set out, Tim, in terms of the lockdowns and social distancing, vaccine rollout. And obviously, the thing that we're optimistic about is the piece in our control, ramping up the capacity and serve -- and utilizing that capacity quickly as we bring it on.

[Operator]

Our next question is from the line of Victoria Petrova from Crédit Suisse.

[Victoria Petrova, Research Analyst]

I have 2. The first is on Zoom. Do you currently operate one Acton capacity? Or do you have another one? And what level of automation is there at? I remember it used to be sort of semi-manual. Have you introduced more automation in this facility?And my second question is around capacity. Obviously, you've delivered the highest revenues ever in the first quarter '21. However, the average order per week, low at GBP 147, is 30,000 less than in the fourth quarter 2020. I do understand that part of it is just the basket level. Is there anything else? Because I would have expected you to benefit from Erith expansion and also Bristol introduction. I know it's just a little bit, but we haven't seen any of that. So have there been any other factors with capacity constrained in the first quarter apart from big basket?

[Timothy Steiner, CEO & Executive Director]

So I think the way to think about it, Victoria, is actually just to think about the gross sales rather than order volume. So that kind of, obviously, as baskets get larger, then we're able to serve less customers. So what you've seen here is 40% year-on-year growth and growth quarter-on-quarter as well as we brought more capacity online. The new site in Bristol is extremely new. So it's actually only just gone online. So it didn't really -- it didn't go online in Q1. It's gone online for Q2. So you shouldn't be -- yes, you shouldn't be surprised to see anything there. So we'll see the benefits of that growth through the course of Q2, 3 and 4. We'll see the growth in the new sites in Q4.And then your other question was -- and obviously, in terms of the order volume, if the basket size goes down, then we'll see an increase in the number of orders per week on top of the underlying total increase in volume that we're shipping. So if you think about [ each ] volume that we're constantly increasing, that's generating the increasing sales, and then you divide it by the kind of basket size to get an order volume per week.Your question on Zoom, can you just repeat your question on Zoom for me? Sorry.

[Victoria Petrova, Research Analyst]

Do you have one capacity, this Acton capacity...

[Timothy Steiner, CEO & Executive Director]

Sorry, I'm with you. Sorry, sorry. Apologies. So we have one Zoom live at the moment. Yes, that Zoom does not have end-game automation in it. It is much more manual and requires a larger footprint than the Zoom sites that we are looking to roll out now and our offering to our customers. So that site was something that we could get live quickly, enabling us to trial the service, enabling us to get a better understanding of the things, for example, like the chilled-ambient mix, the item size, the demand, the basket size, the shape of week, the elasticity of demand for different delivery pricing and all types of things that we could learn so that we could optimize the final design. So we can now build Zooms on a significantly smaller footprint than that using our own proprietary automation and deliver far higher productivity in those sites, enabling us to help our clients to create long-term, sustainable, profitable immediacy orders from those sites.

[Victoria Petrova, Research Analyst]

May I ask just one follow-up? In terms of capacity, should we just look at pound capacity, not an order per week? Is it a better indication for...

[Timothy Steiner, CEO & Executive Director]

Look, it's a better indication of the warehouse capacity, yes. I think people are -- obviously, the size of basket is something that is an important variable for us because we need to deliver to the number of households that we deliver to. So as the basket size rose, that obviously helped our economics because when a vehicle leaves -- some vehicles are weighed out, some are queued out and some are timed out. The ones that are timed out were able to deliver more groceries in the last year than they did in the previous year because the basket size is bigger, which gave us an improvement in delivery economics.So I think it's still something that's very important to keep an eye on, as it always has been. It's always been something we've reported on. But you need to think about both because if the basket size goes up, expect to do less orders. If the basket size goes down, expect to do more orders versus what your expectation was before. So look at all of it.

[Operator]

Our next question is from the line of James Grzinic from Jefferies.

[James Robert Grzinic, Equity Analyst]

Yes. Thank you. I just had a couple of very quick ones, Tim. The first one is, can you perhaps help us understand how the Zoom capacity takes from -- eats into the CFC capacity that supports the Zoom site?And second one, what does, I guess, again, to Zoom, CapEx look like fully automated? That would be really helpful to understand.

[Timothy Steiner, CEO & Executive Director]

Sure, James. In terms of the CFC capacity that it eats into, it's a very good question because our clients' networks of Zooms, because they can be part of an ecosystem with the larger warehouses, they have a significant offer and hundreds of basis points of operating advantage over a stand-alone equally automated micro site run by somebody else. And the reason is they can get their inbound from the larger CFC, where they can, for example, just have a [ cross-stop ] into -- or not a [ cross-stop ] -- sorry, an entire tote that's been decanted in the larger warehouse to ship to them, or they can have a tote with multiple SKUs that has been single-picked can also be delivered to them. So they're able to have a much more efficient supply chain, inbound operation, lower waste and higher levels of stock availability, which will amount to several hundred basis points of operating cost advantage over an alternative.But as, James, said, that does use up a bit of the CFC capacity. And it's a multiplier, and as in -- for every GBP 20 million of sales that you get in the Zoom, you're losing somewhere between GBP 2 million to GBP 3.5 million of sales capacity in the bigger warehouse. So it's got -- whilst it does take some sales capacity from the larger warehouse, it's a very -- it's a much smaller number than the amount of sales capacity that it overall adds.

[James Robert Grzinic, Equity Analyst]

So just on that point specifically, does it mean that you need more kit above and beyond the grade? And how do you reconfigure it for that? How do you repurpose it for that?

[Timothy Steiner, CEO & Executive Director]

No, it needs very little incremental kit. It largely can leverage what's already there in terms of the inbound decant capacity and single-picked capacity. It's just that it uses a little bit of it to -- and the bot movements. It just uses a bit of that capacity to have that -- those goods flow through in the way they need to flow through to get to a Zoom site. So it's somewhere between kind of 5 and 10x the amount of capacity used in the big warehouse is the sales capacity of the Zoom that, that supports, right?In terms of the CapEx in the Zoom, I think the way for you to think about it is it's obviously slightly higher than the amount of CapEx on a CapEx-to-sales ratio in a big site because you obviously lose some economy of scale as you move down in scale in terms of you still need to have a safety system, you still need to have a maintenance area and you need to have a crash barrier. And the crash barrier on a smaller grid obviously has -- it has more perimeter for the amount of volume than a bigger one. So there's a slightly higher CapEx. And it's marginally offset by the fact that it does leverage the larger sites' inbound capabilities and, therefore, has a simpler inbound operation. It has a simpler dispatch to customer operation. So it's not dramatically different as a percentage of the sales capacity.

[James Robert Grzinic, Equity Analyst]

So would that be like a low double-digit at pre-working capital offsets? And is that the sort of number we should be thinking?

[Timothy Steiner, CEO & Executive Director]

It's a low double-digit. It's correct.

[Operator]

This concludes the Q&A. So I'd like to hand back to David for any closing points.

[David M. Shriver, Communications Director]

Thank you very much, everybody. That concludes our call. We're going to report next on the 6th of July with Ocado Group's first half 2021 results. I'm sure we'll be speaking to all of you before then. But for the moment, thank you, and have a good day.

[Operator]

This now concludes today's call. Thank you all for joining. You may now disconnect your lines.