Ocado Group PLC

LSE:OCDO

Earnings Call Transcript 2020-Q3

[Operator]

Hello, and welcome to the Ocado investor analyst update. I'll shortly be handing you over to Duncan Tatton-Brown and David Shriver, who will take you through today's presentation. And there'll be an opportunity for Q&A later in the call. For now, over to Duncan and David at Ocado.

[David M. Shriver, Communications Director]

Good morning, everyone. This is David Shriver, Communications Director of Ocado Group. Welcome to the third quarter trading update for Ocado Retail, which, as you all know, is a 50-50 joint venture between Ocado Group and Marks & Spencer. Our Chief Financial Officer, Duncan Tatton-Brown, will give you a brief summary of Ocado Retail's performance in Q3 as well as an update on the switchover to M&S on the 1st of September and then we'll go to questions. Duncan, over to you.

[Duncan Tatton-Brown]

Thank you, David. Ocado Retail has had another quarter of growth as update. Sales in Q3 grew 52%, representing a further acceleration compared to the 44% growth we recorded in quarter 2. A number of factors have driven this. First, orders per week have returned to positive growth, thanks to a combination of strong demand, a phase reopening of the website to new customers and some normalizing of shopping pattern. Second, average order size remains above precrisis levels of GBP 141, although it continues to normalize from its highest COVID-related peaks. And third, the year-on-year comparables highlight the strong demand we're seeing. Online shopping is increasingly attractive to customers, and we continued to see the smoothing of demand over the week, enabling us to serve the highest level of demand. In this quarter, we compare against seasonally softer growth in Q3 2019, a quarter where many customers have traditionally taken holidays away from home. I'm delighted to report that customers have responded very positively to the switchover to M&S products on the 1st of September. M&S products have increased the average basket by around 5 items and are driving strong forward demand, including our biggest ever forward order day on the day of launch. Over 98% of customers are already shopping M&S. The initial range of 4,400 food products replaces around 4,000 Waitrose products, providing high-quality alternatives at the same or better prices, M&S favorites and hundreds of completely new products, which reflect trends that ocado.com customers are most excited about, such as M&S Plant Kitchen, Organic and the Remarksable Made Without ranges. We expect to add around 800 more M&S products to the range in the coming months, including the launch of M&S' Christmas ranges, Entertain by Ocado and further new product developments. In addition, ocado.com now features around 700 M&S Home & Lifestyle product lines, further enriching the hypermarket offer for customers, with M&S hero categories such as toiletries, baby, kitchen, dining and household. As customers turn an increasing numbers to buy their groceries online, we're confident that Ocado can offer the best value, the widest range and the highest levels of service to an increasing number of customers. In this way, Ocado Retail is well positioned to remain the U.K.'s fastest-growing grocery retailer. A quick word on our immediacy business, Ocado Zoom. The performance of Zoom remains both positive and encouraging, and we're currently planning the rollout of additional micro fulfillment center. Zoom is part of the flexible Ocado smart platform ecosystem, which allows Ocado Retail as well as, in time, our other international partners, the ability to offer customers the best value and service from the big basket shop to the top-up shop within an hour of order. As a result of the strong performance we've seen, we're modifying our financial guidance for the year. While uncertainties remain such as the impact of social distancing restrictions in the U.K., the strong trading performance of Ocado Retail in the first 3 quarters of the year, combined with the impact of operational leverage in the retail business, suggest a full year EBITDA result for Ocado Group of at least GBP 40 million versus current consensus of GBP 26 million, which you can see in the Investors section of the group website. With that, I'm now happy to take your questions.

[Operator]

[Operator Instructions] Our first question is over the line of Thomas Davies at Berenberg.

[Thomas Davies, Analyst]

I guess just one question from me. So just on your commentary then on Ocado Zoom. Given it's likely to take time to build that network of microfulfillment centers, would you consider leveraging some of the M&S store estate as a way to capture market share for this in the near term?

[Duncan Tatton-Brown]

Yes. I mean, I think the -- I think everybody is aware that the platform that we operate enables a variety of ways of serving the customer, obviously, with our standard size CFC; mini-CFC; Bristol CFC, due to open in the first quarter of next year; and micro CFC, like the one we have in West London. But we also provide in-store fulfillment technology used by Morrisons, and I expect an increasing number of our customers. So yes, there is always the possibility that, with M&S, we look to do that. And you can imagine some benefits to Ocado Retail of that, if that was in areas that are currently not served by Ocado Retail. But they're nothing specific to say today, but yes, it remains a possibility.

[Operator]

We now go to the line of Marcus Diebel at JPMorgan.

[Marcus Diebel, Research Analyst]

Questions from my side. Duncan, could you talk about any change in customer behavior? I'm just looking, obviously, very impressive growth now in the third quarter. What I would be interested in is, that the recent cohorts you acquired, yes, so the new customers that came to the platform recently, it looks like they're very sticky, not changing. Is that fair? And then the second question is on Zoom and competition here. Clearly, we see a lot of food delivery players going into the space. Could you talk maybe a little bit about the benefits that you are seeing in terms of costs that you might have over them? And how you see the development of deliver partnering with [ Waitrose ] or potentially also just ease going into some delivery options? Just how you see this impacting Zoom. I mean it's basically in terms of your rollout, everything on track, that would also be interesting.

[Duncan Tatton-Brown]

Yes. Sure, Marcus. Yes, in terms of customer behavior, customer behavior is starting to normalize, as we talked about, in terms of basket size. And -- but the sort of the long-term dynamics of the Ocado customer remain true, which is they are traditionally very sticky once they become a regular shopper, which typically we see if they've shopped us 5x. So those sort of long-term trends are there. The team in Ocado Retail are working hard to identify ways of finding the best customers and to add to the growing number of customers we can serve. Clearly, we are still capacity constrained, but I think we're having some success at acquiring better. From Zoom's perspective, yes, we think the Zoom proposition is a better proposition for both the retailer and the customer. The customer gets access to over 10,000 products delivered within an hour. So it is a very different proposition to most of the other food delivery propositions, which are much more limited, substantially more limited in range. This is almost like a full supermarket, a small supermarket range available within an hour, at pricing, which is very close to supermarket pricing because our Zoom pricing is very close to ocado.com pricing. And we enable that by using the automation and the capabilities of our larger fulfillment centers. So receiving goods in the large CFCs and enabling to -- decanting and putting them into stock totes using the efficient automation in those large CFCs, which enables us to take cost out versus a sort of traditional convenience offer. So yes, we think this works for the customer and it works for the retailer. And we'd expect to see a lot more of them in the U.K. for Ocado Retail, and ultimately, I think, from our platform customers globally.

[Marcus Diebel, Research Analyst]

Perfect. Maybe just as a follow-up to the first question. So it really is the case that maybe those customers that you acquired recently maybe came for different reasons than customers in the past where they'd signed during the pandemic. But it seems though those have been properly converted and the churn of those customers is very, very low, right? Is that a fair assumption?

[Duncan Tatton-Brown]

Well, I think, Marcus, what is important to note is we're not out there trying to add a lot of customers at the moment. We -- there is so much demand for online grocery. We're not out seeking lots of customers, spending a lot of money on marketing to acquire customers because there was a lot of pent-up demand. And if there's a lot of demand, then customers generally are quite loyal. So we think it's a good position. Obviously, importantly, we're adding 40% capacity next year. And we think the channel shift, which has substantially accelerated, will give great opportunities for Ocado, the Retail, to grow over the next few years once we can add a lot more capacity. And I have no doubt, we're looking at adding more capacity beyond the 3 CFCs that we're on track to open next year.

[Operator]

Next question is over the line of Andrew Gwynn at Exane.

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

Duncan, well, first off, best of luck in your new endeavors. I'm sure you'll be hopefully as successful as you've been at Ocado. So best of luck and thanks over the years. Just going to my questions. I've got lots actually, but I'll try and limit them. The first is just on a report in the Grocer, which suggested that Ocado Retail is essentially out there beating up suppliers, demanding pretty significant price cuts. I think the figure mentioned was 7.5%. So I'm just wondering if you could comment on that. It does seem quite aggressive. The second is just on capacity. You've mentioned that 40% figure, but I guess that's probably towards the tail end of 2021. Obviously, a significant demand at the moment, but the group's growth is largely constrained by capacity. So maybe just a little bit of help for short term to model the coming quarters as how that capacity might phase. And then the final question -- and I've got another one, but I'll leave it on that. Just on the M&S products, I mean, 5 extra M&S products sounds pretty good. But I think the basket is down sequentially versus Q2. So I'm just wondering what the missing part is in that story.

[Duncan Tatton-Brown]

Andrew, you disguised 3 really nice challenging questions with some nice words at the outset. So nicely done, Andrew. I will miss your questioning as well. On the -- on your 3 points. Yes, I'm going to think there's a little bit of noise around the sort of the annual negotiation debate with suppliers this year. I wouldn't read too much into that. I think there is opportunities for Ocado Retail to secure better terms from its suppliers over time. I think quite likely so, the business is growing. We're the fastest-growing grocery in the U.K. There's great opportunities for our suppliers, given our arrangements with M&S. So the opportunity for supplier with Ocado and M&S is much greater than it was before. So I think it's absolutely right that we'll look to improve terms. But we work well with suppliers, both big and small. And I don't think you should expect this to be anything out of the ordinary. Just a little bit of noise that comes at this time of year when there's a bit of a negotiation.On capacity, you're absolutely right. The 40% is the aggregate extra capacity from the 3 facilities were due to open next year. Bristol, which is the smallest of those, will open in the first quarter. The next 2 will open sort of mid-year stroke end of year. So we won't be adding 40% of capacity in the first quarter. But if you think about it, Bristol is about 30,000 orders per week. We'd expect to ramp that relatively quickly at a current level of a 350,000 orders per week of demand. You're getting close to adding about 10% capacity through the first quarter. So capacity is coming on as it were on a ramped basis across the year.In terms of basket size, one of the things in, Andrew, in your commentary there, we talked about products. So it's sort of items rather than numbers of products. So we're selling more M&S products than we were selling of our previous supply partner in terms of different product types. But of course, over time, we're not seeing the same multiple items of the same product. So rather than buying 2 blocks of cheese, people are down to 1 block of cheese. Rather than buying 4 pints of milk, they're down to 2 pints of milk. Whatever it might be. So the choice of the M&S product range has gone up from our previous supply partner.

[Operator]

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

[Nick Coulter, Director]

Duncan, just on a personal note, if I could add my very best wishes to you and your family. It's been an absolute pleasure. So very best to you. If I may, I'm not wishing to depart from custom, I also have several questions. Firstly, just on those 5 extra items. Is that 5 extra own label items or is that 5 extra items to the basket? That will be the first one.

[Duncan Tatton-Brown]

Nick, I'll jump straight in that because it's a simple one. Again, thanks very much for your kind words. It's 5 extra products and own label products. So this is M&S-branded products versus Waitrose-branded products.

[Nick Coulter, Director]

So you've seen a step-up in your basket size, overall basket size, or just your own participation?

[Duncan Tatton-Brown]

Yes. So there is a greater participation of M&S' own label than there was prior to the Andover, Waitrose own label. So yes, own label...

[Nick Coulter, Director]

But that's just customers just substituting, right? So I guess what I'm trying to say is that if you've seen a jump in 5 underlying items, then that's clearly quite a sizable dividend to reap from the M&S changeover. But I'm just trying to clarify that point.

[Duncan Tatton-Brown]

Yes. I mean, I think the answer on that is, of course, I think it is, yes. And I think that reflects the quality of the M&S range. I think it reflects the fact that there's a lot of products that customers want from M&S. Of course, some of it maybe. Maybe this will not sustain adding 10 items. Some of it may be the customers trying out because you think this is the first 2 weeks of customers trying out all of the M&S product and wanting to experience more of the range. I think it is notable as well. Of course, ocado.com can list more of the great M&S range than Austin, your local M&S can list because they're not all of the M&S stores. So I mean, I think this is just reflective of M&S having a great product range with lots of interesting products and people certainly trying it out, but we think using it more, which is good. It's good for Ocado Retail. It's good for M&S. And it's good for our customers. So we think it's a very good start.

[Nick Coulter, Director]

Great. And just to follow-up on basket trends. I think the average basket dropped by around GBP 20 across sequential quarters. With your visibility over the exit rate and forward orders, should we expect that sort of quantum of drop, which obviously wouldn't be unexpected going forward?

[Duncan Tatton-Brown]

Nick, I think it's difficult to predict. But I think, as you and everybody will know, this really just depends on the overall behavior in the U.K. With the government helping, encourage eating out as an example, with people increasingly coming back to work, I think there will be a slight reduction in calories consumed at the home. And therefore, yes, I would expect, over time, the basket size will decline. But I and you and none of us really know what might happen around any further lockdowns, local lockdowns, national lockdowns. So we can't be completely sure. And the winter months will obviously create some potential changes there. So is it going to be the same reduction in the next quarter as in the last quarter? I don't know. I hope for the nation's sake that we're getting back to normal as soon as possible, and therefore, that might be a reduction in basket size.

[Nick Coulter, Director]

All right. And just to that point, in terms of normalization, and to follow up on an earlier question. Could you run through the capacity as it stands on a normalized basis for each CFC at the moment, please, and how we might expect Erith to build in the coming quarters, please?

[Duncan Tatton-Brown]

Yes. So well, Erith in the quarter is running at around, sort of peaking at around, say, 120,000 orders per week. Not a sort of a massive step change versus the half year. We're obviously quite preoccupied with the switchover to M&S as a sort of a bigger focus in the quarter. We'd expect Erith to continue to grow through the balance of this year and obviously into next because at that level, it's still got some decent opportunity to grow into its capacity. The other facilities continue to operate at very high levels. Dordon in aggregate, for both ocado.com and for morrisons.com, over 200,000. And Hatfield running at high levels. And then we're adding the Bristol, the Andover and per fleet next year, which are sort of round numbers, 30,000, 60,000 and 80,000 orders per week capacity across those three. So there's a lot more capacity to come. And I think it's important to note that when we opened Erith, we were able to scale Erith to the same level of Andover very, very much quicker than we did at Andover. And I think that's sort of symptomatic of what you should expect. We'd expect to be able to ramp these new facilities to their maximum level quicker than we've done previously with the constraint -- the human constraint of hiring people rather than any technology constraint in terms of working on how to operate from high capacities. So that's good news. It's good news for Ocado Retail. They can grow faster. But I think it's obviously symptomatic of our capabilities for international clients as well.

[Nick Coulter, Director]

And then last one, if I may. Please, can you just talk a little bit about your Store Pick solution? Perhaps highlighting where the OSP solution differs from those or other solutions around the world to Store Pick. So Morrison has clearly been a keen customer, and Sobeys have also been talking about the services as kind of a pathfinder recently. So it would be interesting to hear your thoughts and then some more detail, please.

[Duncan Tatton-Brown]

Yes. I mean, I think the Store Pick process is a -- as it were a simple process because it's a much more manual process. So our technology strength gives us less opportunity to demonstrate its strength in Store Pick. But it still uses all the interfaces that we have, which are designed, refined over years how to operate online grocery. So great search functions, great features on those facilities. It still can use the routine algorithms to optimize and run those facilities, the fleet, the best possible efficiency. It still includes the interfaces for the driver. So it gets all of those benefits. Obviously, it's a manual process picking from store, so there's less smart in that technology than you would see in Erith as an example. But it is capable.

[Nick Coulter, Director]

So I was asking if you can still see the stockpile, so you avoid substitutions or not. I guess that might depend on the partner.

[Duncan Tatton-Brown]

It is. And Nick, we're starting to get sort of a quite detailed level, so maybe we can pick that up another time.

[Operator]

Okay. We now go to the line of Rob Joyce at Goldman Sachs.

[Robert Joyce, Equity Analyst]

Just that -- yes, first, I'd like to reiterate the congratulations, many thanks, and best wishes for the future. I've got 3, I think, I'll go with. Firstly, sorry, I hope not flogging a dead horse, but just to try and understand going into that at the end of the year now. What kind of capacity do we have in terms of the -- what sales growth could be done with the capacity you expect to add to the system in that fourth quarter and presuming 52% will be quite an ask in that fourth quarter?On Erith, do you have an idea when Erith will actually get to the sort of 220 or so orders per week that you hope to do at capacity? And has anything you've seen in the operating of Erith above that half capacity changed your expectations for the output or the economics of that site? And then final one, just -- I think Tim mentioned, was it 1 million people on a waiting list or something like that from M&S that you've taken over or it showed signs of interest. Any update on the numbers in that waiting list at the moment?

[Duncan Tatton-Brown]

Yes. Many thanks, Rob. Quarter 4, yes, what we really experienced and a large part of the quarter 3 growth, I think people need to understand, was lower comparatives in the prior quarter 3 because that's typically the time people are away on holiday rather than adding significant amounts of capacity in quarter 3. So we're running at the limits of our capacity. And there will be modest capacity growth in percentage terms in the fourth quarter because the only one of our facilities we can add more capacity to. The others running at full capacity is in Erith. So it's going to be difficult to sustain the same sales growth in the fourth quarter because it's the absolute levels of sales that we're sustaining and growing modestly rather than the year-on-year growth. So that should give you a sense that it will be a lower growth. I think you should expect a lower growth in the fourth quarter. Lower growth does not mean less demand. It just means we're continuing to serve the same amount of demand. We're not able to grow at the rate we would like to if we had more capacity. Your second question was, how will Erith ramp to full capacity? I think it's uncertain because we've never done it. We never operated a facility at that scale before. But I think history says for Ocado, we should expect to get to 80% or 90% of the full capacity in a pretty straight line from where we've gone so far. By the time we get kind of squeeze that last 10% out, maybe that will take us a little bit longer. But the economics will look very good even only operating at 90% full capacity. What I'm certain of, based on my history with Ocado, is, ultimately, we'll probably end up at well more than 100% because that's what we've done on all of the previous facilities we've operated. We set a target. We get pretty close to it quite quickly. Getting them to the maximum takes a little bit longer, but ultimately end up much higher above that. We're well over the predicted capacity in Dordon, as an example, and massively over in Hatfield.Last question, Rob, on M&S. I think the demand from M&S customers is still there. I don't think there's a particular update on that. Remember, we're only 2 weeks in. Remember, we're capacity constrained, can't serve a lot more customers. But the prospects for those M&S customers who want online groceries through ocado.com, I think, will remain good, but it just come over time as we can grow capacity.

[Operator]

We now go to the line of Xavier Le Mené at Bank of America.

[Xavier Le Mené]

Yes. Can you hear me?

[Duncan Tatton-Brown]

Yes, I can, Xavier.

[Xavier Le Mené]

Best wishes, Duncan, for the future. For me, you were just talking about the size of your best customers. So I just want to understand what you mean by your best customers when you were trying to open to a bit more customers, I think. Second question, actually, you said you reopened the website during Q3 then to new customers. What is the profile of these new customers? Are they coming from the competition? Are they brand-new customers to online?

[Duncan Tatton-Brown]

Xavier, thank you again. Yes. I mean, I think best customers for us are -- that they're not -- they don't have a particular characteristic to make them special. They're just regular shoppers with reasonable basket sizes. Obviously, for us, that typically means families because families with children, there's just more mouths to feed at home so they consume more groceries at home, and that makes them attractive to us. And that's the biggest driver for us at basket size is the size of the household. Xavier, apologies, I've forgotten your second question. Can you remind me?

[Xavier Le Mené]

Yes, second question. Yes, it was just getting new customers, you say, in Q3 because you open your website. What is the profile of these new customers?

[Duncan Tatton-Brown]

Yes. Xavier, probably not much to say there because the growth in new customers has been quite modest. I don't think there's any sort of indication of a changing type of customers. Without -- and without knowing the answer, what I'd expect to say on that is that a lot of the customers who joined us or new to us have shopped somewhere else previously because we find it easier to attract online shoppers from elsewhere typically. But I know because this is just the nature of where we live in at the moment. So there's a lot of pent-up demand for online grocery. So some of this would just be new people trying it for the first time when they can.

[Operator]

Our next question is over the line of Simon Bowler at Numis.

[Simon Bowler, Analyst]

Just a quick one just on any kind of things to call out on the cost structure within Ocado Retail. You kind of mentioned the idea that there's not a significant need to invest into kind of new customer acquisition, so potentially kind of the marketing line seeing some leverage and also quite a big swing factor in gross margin in the first half. And just any kind of early thoughts about how we should think about that across the second half.

[Duncan Tatton-Brown]

Yes, there are some benefits given the current demand and dynamics. You've already picked up on one, Simon, which is in sort of marketing costs. So lower marketing cost. I think the scale of demand, the efficiency of the proposition has sort of lower customer compensation at the moment. There's less costs associated with things like that, with less missed deliveries. This is a very small cost to us. But it's a good example of the fact when there's such high demand and customers are at home, there's less opportunity for them to forget. They've got the delivery coming and not be there, which is a cost to us. So we have a number of items like that. Outside of that, there's no significant other trend to pick up on. There's still some cost inflation from wage. We continue to grow the salaries of our employees. No, there's nothing particular elsewhere. The leverage I referred to earlier, it's more symptomatic of the fact that as we grow capacity with the same fixed cost, we're seeing that leverage. And of course, now going into next year, opening 3 facility during next year. There will be some additional fixed costs coming into next year, which then we'll see the benefits of the operational leverage in the year and 2 years after that. No, so Simon, a long-winded answer to say there's nothing material on costs to comment on.

[Operator]

Our final question for today is over the line of Nick Coulter at Citi.

[Nick Coulter, Director]

Sorry, just a quickly follow-up, if I may. Is it possible to talk about the teething issues with the M&S switchover? I guess you're notably and somewhere understandably have to iron out some wrinkles in processes or product. And then secondly, it being an Ocado Retail trading statement, would it be possible to comment on the ORL consensus EBITDA, please? Clearly, it's going up.

[Duncan Tatton-Brown]

Nick, thank you. Yes. So this was a massive undertaking, transferring out 4,000 products, which we're selling up until the last day and replacing them with 4,400 new products. Actually, we're selling them the day after. So it's a pretty massive undertaking. And the operations actually did incredibly well. We're really pleased with the way that went. We were surprised, but nicely surprised by sort of last-minute surge in demand, which, ultimately, it just meant that we were a little bit short of stock right at that last minute, which created that problem. So overall, we're very, very pleased with the Andover. And I think with only that small issue, and that issue driven by ex demand, we're very pleased. In terms of numbers by segment for us at Ocado Group, Nick, I won't answer that in any specific detail because many of you have different bases to come from. I think what you should take from today's statement is the GBP 26 million to over -- for at least GBP 40 million, simplistically add GBP 14 million to whatever you have in your retail segments, and that's simplistically the way to answer that because many of you start in slightly different places, it's not worth getting into the specific figure for each of you. But I think that will simply answer your question, hopefully.

[Operator]

With that, can I please pass back to you for any closing comments at this stage?

[David M. Shriver, Communications Director]

Well, thank you, ladies and gentlemen. That concludes our call. We'll report next on the 10th of December with Ocado Retail's Q4 trading update. I look forward to speaking to many of you before then. But in the meantime, keep well, and have a good day. Bye now.

[Operator]

This now concludes today's call. So thank you all very much for attending, and you can now disconnect.