Ocado Group PLC

LSE:OCDO

Earnings Call Transcript 2019-Q4

[Operator]

Good day and welcome to the Ocado Q4 Analyst Call. [Operator Instructions] Just to remind you, this conference call is being recorded.Today, I am pleased to present David Shriver and Duncan Tatton-Brown. Please go ahead with your meeting.

[David M. Shriver, Communications Director]

Thank you, operator. Good morning, everyone. This is David Shriver, Communications Director in Ocado Group. Welcome to the fourth quarter sales analyst call for Ocado Retail, which, as you all know, is now a 50-50 joint venture between M&S and Ocado Group. Our Chief Financial Officer, Duncan Tatton-Brown, will give you a summary of Ocado Retail's performance in Q4, and then we'll go to questions.Duncan, over to you.

[Duncan Tatton-Brown]

Thank you, David. We're delighted to report continued good sales growth at Ocado Retail over the fourth quarter, the first full quarter of its new journey as a joint venture between Ocado Group and M&S. Under the leadership of Mel Smith, a strong collaboration between M&S and Ocado Group has been established and Ocado Retail has made very significant progress preparing for the switchover from Waitrose to M&S in September next year.The team has completed the range review of all products currently supplied by Waitrose and has confirmed that M&S has equally -- equivalently priced substitutes of the same or better quality of a great majority of these items. It's worthwhile recalling that the Waitrose range represents less than 8% of all products sold on ocado.com or just over 4,000 lines out of the total available of over 55,000. We anticipate adding many more additional M&S lines to the range, which has never been available online before, so that customers will have more choice than ever when they shop with Ocado.Over the quarter, Ocado Retail has been able to offer customers more delivery options as capacity at Ocado's largest Customer Fulfillment Centre in Erith, Southeast London increased to over 70,000 orders per week. Going forward, Ocado will be bringing customers not only more choice, but also more convenience as even more slots become available with the opening of the first of our mini CFCs in Bristol, which will do around 30,000 orders per week, followed by the opening of Purfleet, which will do around 80,000 orders per week, and the reopening of Andover with around 60,000 orders per week. We're also well advanced in the planning of our second Ocado Zoom microfulfillment site.New capacity in the quarter helped support growth in customer orders of 10.4%. Despite strong growth in new capacity at Erith, this number was around 1 percentage point lower than that in the third quarter when we could take advantage of the lower volumes over the summer, which gave us spare capacity to grow into.The average basket, meanwhile, was stable. As a result, overall revenue grew 10.8%, in line with the 10% to 15% range as we guided at Ocado Group's half year results.Looking ahead to Christmas, we expect our best festive season ever. We have seen more searches than this time last year for Christmas party food, Christmas desserts and chocolate cakes. We've also seen a very high search rates for vegan and gluten-free products. And the fact that our range is not constrained by the falls of the supermarket means that we can offer significantly more choice than our competitors.In short, we're very excited by the progress we're seeing in the business and Ocado Retail is well positioned to accelerate its leadership in the channel and help transform grocery retail in the U.K.So with that, I'm now happy to take your questions.

[Operator]

[Operator Instructions] The first question is from Bruno Monteyne, Bernstein.

[Bruno Monteyne, Senior Analyst]

You talked about the efficiency of the Erith facility being already [indiscernible], can you comment on the engineering cost in Erith? I know it was a big discussion point before on Andover whether it was reducing fast enough. So are the engineering cost of Erith already below or at level what Andover was and how much more progress do we have there?My second question links to the rate of growth you see in your business. In the past, it's been largely capacity constrained, sort of how quickly you can build capacity, a few questions around that. Is that still the case? And then second of all, do you see any reason why the level of capacity growth should accelerate or decelerate in the future years? And is there any risk?[Technical Difficulty]

[Duncan Tatton-Brown]

Operator, can you hear me?

[Operator]

Yes. Sure. The next question is from James Anstead, Barclays.

[Duncan Tatton-Brown]

Sorry.

[James Robert Anstead, Director]

We cut Bruno off? Yes. So I'll ask my questions and Bruno will get back to you. Yes. Yes. Sorry about that. Two probably smaller questions and Bruno was asking.

[Operator]

[ Madam ]

[James Robert Anstead, Director]

Okay. Should I continue?

[Duncan Tatton-Brown]

James, please continue. Yes.

[James Robert Anstead, Director]

Yes. Sorry about that. Okay. So the first one, when you had the convertible bond launch last week, you talked about fourth quarter order growth being slightly higher than revenue growth, including Zoom. And the statement today has got a lower growth in orders and revenue, I think that's excluding Zoom. So I think you can do some simple math and that would suggest that Zoom must be doing somewhere around 2,000 orders per week. So does that sound about right? That's the first thing.And then the second thing was you tantalized us with talk of a January seminar, not just on IFRS 16, but also on other accounting topics. I just wondered if there's anything else you'd like to highlight ahead of time, given that most accounting issues tend to be bad news rather than good news for reported earnings.

[Duncan Tatton-Brown]

Okay. So I'm glad you're intrigued about the other accounting topics. I think the important thing there is to recognize that how we report [ LRL ] and the rest of our business will have to be slightly different going forward. So that's an accounting type topic, so you should expect a very exciting presentation in mid-January as we've now done for a couple of years. So I hope you look forward to that.On Zoom, no, I think there's another way of looking at this. And perhaps if I do this once, this will help everybody. Approximately, you can see in the release the 10.8% revenue growth was at 10.4% order growth and flat basket, so that would imply with the roundings, you've got about 0.4% of revenue growth from Zoom. And to make the maths easier, let's just assume, this isn't what it is. I'm just making this assumption, you can use your own assumption, but assume that Zoom's basket is GBP 40. And to make the maths easy, an ocado.com basket is GBP 100. So that would take your 0.4% revenue growth to be about 1% order growth, and 1% of the orders -- we ended the quarter with 350,000 orders, so you can see, if those maths were correct, you're about 3,500 orders. So you can see it's a bit more than your 2,000 orders. I'm not saying it's 3.5 because that's rounded and simple maths, but you get a sense it's a little bit bigger.

[Operator]

Sir, Bruno is back in line. I will open up your line again and you could ask or continue your questions.

[Bruno Monteyne, Senior Analyst]

[indiscernible] That was the second time I fall off today. I think that you get most of the questions or should I repeat them all vertically?

[Duncan Tatton-Brown]

I've got the engineering one and you were starting on rate of growth and you were cut off in the middle of rate of growth.

[Bruno Monteyne, Senior Analyst]

Okay. On the rate of growth, I understand, historically, you were capacity constrained. And there's 3 questions. Is that still the case? Second of all, should that capacity grow go up or down? And is there any risk that the M&S transition makes you slow down the capacity growth next year as you have other things to worry about?

[Duncan Tatton-Brown]

Okay. In engineering costs, we'll talk a little bit more about that at the end of the year. So I won't specifically mention anything now. But I think, needless to say, our assumptions around the long-term viability of the solution are unchanged and we'll talk more specific about progress when we get to a profit-type report, which is not now, it's in February.On capacity, yes, we believe we're capacity constrained. And you've heard us talk of quite substantial amounts of new capacity that we're bringing onstream. But the only new capacity that you should expect through most of next year is Erith ramping further. So we will still be capacity constrained into next year. But by the end of the year, we're expecting to open Bristol, and then relatively soon after, Purfleet and Andover in the years to come. So yes, we will still have some capacity constraint.I don't think the transition from Waitrose products to M&S will fundamentally change that. I think both us and M&S would like to have more capacity because we think there's a great opportunity to grow faster. But there's the -- building of capacity takes some time.

[Operator]

The next question is from Andrew Porteous, HSBC.

[Andrew Ian Porteous, Analyst, European Retail]

A quick one for me. Just when you're talking about the sort of smaller CFCs on Bristol and Purfleet, what does their financial profile look like? Do they ramp up a bit quicker? Do they have -- are the sort of the start-up losses proportional to some of the bigger CFCs you've opened? Or could you give us some sort of color about how you're thinking about that?

[Duncan Tatton-Brown]

Yes. So Bristol is what we would call now a mini CFC. Purfleet isn't. Purfleet is at around 80,000 orders, is bigger than Andover at around 60,000 orders. As it were, Erith is the outlier being a much bigger facility in Southeast London inside the M25. So we took the opportunity, because it was inside the M25, to build a much bigger facility.What are the characteristics? The overall economics, as we said in the Bristol announcement, is that mini CFCs, the economics are basically broadly similar or almost similar. But of course, the benefit of smaller facilities, which is that they generally can do more of their demand direct to consumers, so there's a timing benefit for the consumer. And there is also, from a profitability perspective, the likelihood of ramping to full capacity more quickly.So if you build 2 half size CFCs, you can phase the opening of the second one such that you're filling up the first one before you go to the second one. So there is a slight benefit there. But these are facilities that are as efficient as our newest facilities are expected to be. And you saw in the release today that Erith is now running at an operational efficiency now better than Hatfield, so there's a real sign of progress there.

[Andrew Ian Porteous, Analyst, European Retail]

Just when you're thinking about the M&S here, I think at the time you sort of said that you're planning another 5 CFCs there. Is there a distinction between sort of mini CFCs and normal CFCs? I mean -- or is it just sort of any CFC? Could you give us some idea on what those 5 look like? I mean could it be we get 5 Bristols rather than 5 Andovers, effectively?

[Duncan Tatton-Brown]

Yes. So the figure we talked about was actually 8 CFCs, and the 8 CFCs were effectively Andover-sized CFCs. So it's an amount of capacity you could see. I'm not saying you would see this. You could see 8 Andover-sized facilities or 16 half Andover-sized facilities or any other combination of different sizes. So it's a capacity commitment that the joint venture has made to Ocado Group rather than a number of CFCs.

[Operator]

The next question is from Michael Montani, Evercore ISI.

[Michael David Montani, Managing Director]

I had 2 of them. One was just around what you're seeing in terms of the robotic picking, if there's any updates that you can share in terms of how that's going and efficiencies that are being gained. And then the second one is just around the consumer behavior. So we've done some survey work for U.S. consumers, and what we're seeing is around 60% of them saying they would need to see same-day fulfillment in order to effectively substitute a traditional in-store shop for an online ship-to-home order. And I guess I'm curious to see kind of what you all are seeing there. And then within that light, any progress in terms of the second Zoom facility and uptake thereof?

[Duncan Tatton-Brown]

So on robotic picking, it's live in our Erith facility, but it's live at a relatively modest scale. I won't release any stats or information today. [Audio Gap] But what I can assume that the rates of pick from the robot has improved quite dramatically across the quarter, and we're encouraged and we see a bright future. So it's good progress, but still very modest overall impact because it's still at a very small scale.And from consumer behavior, I think I'm going to focus yet at the responses today on Ocado Retail and Ocado Retail's customer base and not talk about customers internationally. But I think it's very clear in the U.K. that our consumers in the U.K. are very happy to take a large proportion of their demand ordered today for delivery tomorrow.Ocado Retail has offered same-day delivery for probably now more than 10 years, there is a modest take-up of that. I think there's a big difference between immediacy offer and a same-day offer. But no, consumers in the U.K. are very happy with the benefits they get from that order today, delivery tomorrow. And the economics associated means that we can offer very broad range of products at the same price as you buy in a supermarket without the need to add any premiums onto the product, which you need to do if you want to do a lot of immediate deliveries. So I think there's a part in the bucket of both sets. But, no, it's not all easy.Oh, yes, I was just reminded, Zoom progress. We haven't made an announcement of the second facility that you've heard me pretty clearly hints that we're working on one. We have another announcement in early February. That's probably a good time to expect something.

[Operator]

The next question is from Tom Davies, Berenberg.

[Thomas Davies, Analyst]

Just a quick question on the capacity ramp-up with the CFC in Bristol. Will that mean that you have to be self-funded? Or will it require capital from the group or M&S? And second of all, regarding Zoom, are you guys going to be offering it to your partners anytime soon?

[Duncan Tatton-Brown]

So yes, I'm not sure I really understand what you mean by self-funded. You spend capital, there's costs associated to open it. So from an Ocado Retail perspective, Ocado Retail will be paying Ocado Group fees for the provision of the services that Ocado Group provides, and then there'll be a capital cost of building that facility that will ultimately be incurred by Ocado Retail because they are the owner of that facility. So there is clearly a cost to open new capacity, but there's an economic benefit from opening that new capacity. So we expect -- you should expect a lot more of that.Your second question was on Zoom for international clients. Yes, you can match that concept is a concept best with international clients. And when we're ready and when we have an order, we'll let you know about that, but you should expect us to be in discussion.

[Operator]

The next question is from Nick Coulter, Citi.

[Nick Coulter, Director]

Three, if I may, please. Firstly, on capacity, are you constrained to the lower end of the 10% to 15% range, I guess, across peak and into next year? So I guess, in essence, the question is to how quickly you can ramp Erith, which I guess has another [ 140 ] of capacity?Then secondly, there's been some debate in the market on competing solutions in the U.K. or elsewhere using kind of traditional mini shuttle automation, which you, of course, use in your first generation CFCs. Could you perhaps talk to where you see the key benefits of using the high versus an OSR in your solution? I know there's also a whole piece around the end-to-end nature of what you do, but just to focus on that kind of core fulfillment piece?And then lastly, if I may venture a group question on the convertible. Would you be able to run through the rationale as to why you changed the convertible over equity or plain [ vanilla ] debt? And then also comment on the timing please.

[Duncan Tatton-Brown]

Nick, we've got a full set of questions there. So first of all, capacity, so I don't think I would limit us to be part of the 10% to 15% range. I think the reason why today we would have a topic, we're cognizant of how much capacity we have. So I think yes, right, it was the top end of that line in the next financial year. But it's difficult to produce it when we have asking in place.

[Nick Coulter, Director]

You're breaking up a little bit there. But just to be clear, you don't expect to be bumping along at the bottom, but neither do you expect to be at the top? Because you're seeing bumping at the bottom, I guess, is the key question.

[Duncan Tatton-Brown]

Yes. Nick, I haven't answered at the bottom end yet. But I'm not saying that 10% to 15% statement means I actually think it's going to be between 10% and 11%. So I think it is [indiscernible], but that's no promise that it's going to be 12.5%, it's just that this 10% to 15% range.The capabilities of alternative models for using automation in grocery, I think that there is a debate often led by [ those ] who can't have access to our solution. There isn't a debate plus about relative merits on benefits, which solution is better, because we -- I believe we have grocery [indiscernible] globally. So we have some pretty significant knowledge base of how they operate [indiscernible] for us, it's very clear that our solution is better. I won't on this call go into reasons. But I think it's a better solution. And lastly, that is an attractive finance to diversify our funding. It enables us to grow our business. The timing is just pertinent given we just added to our requirements to take the opportunity when the opportunity is there.

[Nick Coulter, Director]

Okay. Good. So just so you know that the line is certainly breaking up a little bit at my end. I don't know if it is for everyone else as well.

[Duncan Tatton-Brown]

No, my apologies, I recognize that there have been a number of problems with the line. We'll look at the recording of the call.

[Operator]

The next question is from Andrew Gwynn, Exane.

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

Apologies, I got dropped off, so if there's any duplication, ignore me. But just on the sales growth trend. I mean, obviously, if we look at the industry, it's pretty horrible out there at the moment. Not much volume growth around. So I'm wondering if you could just help us understand your growth a bit better. So to what extent is it driven by new customers? To what extent is it driven by returning customers?And then the second one, obviously, you talked a lot about the M&S mapping, but obviously, there was always a question around price perception. I'm just wondering what your latest thoughts are there whether or not you sort of hold consumers, whether or not you felt that, that was a journey that you're already on? Clearly, as we move towards that September switchover date, that is going to be a big question for many shoppers.

[Duncan Tatton-Brown]

Okay. So I'm going to address the price survey first. We're not having to conduct a lot of price surveys because M&S are conducting that. But based on those surveys, we're very confident that the M&S product range is attractively priced and, over time, it's being more and more perceived as attractively priced. So we go into this transition with a high degree of confidence that we have the right partner, that they have a great reputation, probably the highest in the U.K., on quality and an improving reputation on price. And the specific range reviews have ensured that we're confident that we'll have the right products across the range to meet our customers' requirements.And actually touching on the surveys, I think it's important to note that we continue to resurvey customers as we had done prior to signing and announcing the deal, and the confidence that we have in the transition has increased, not decreased, over time.So going back to your first question on sales growth. The primary driver of sales growth is new customer demand in existing catchments. Existing customers are continuing to exhibit the same behavior as they have done for years, which is a very, very stable level of spend with existing customers spending sort of GDP-type growth spend increases and the big growth coming from new customers in the same catchments. And this isn't about expanding our geography.

[Operator]

The next question is from Rob Joyce, Goldman Sachs.

[Robert Joyce, Equity Analyst]

Rob Joyce here. Two for me. So firstly, just on the -- it looks like you've ramped up Erith now sort of 70,000 orders a week in, give or take, 18 months. Is that the sort of run rate we should now be expecting for a CFC of that size?And the second one, just I think Andrew touched on the U.K. grocery industry there. Just if you could give us what you're seeing there in terms of the promotional intensity from your competitors and any changes in the rate of food inflation at the moment on the horizon?

[Duncan Tatton-Brown]

Rob. Thank you. On the capacity ramp, I think it's important to note that the Erith ramped to Andover's capacity, the 35,000 orders, very quickly, and we're now at 70,000 orders per week. So I'm not answering your question, I'm answering a different question. I think it gives us a high degree of confidence in our ability to ramp the other facilities that we're building because, as I said, Erith is like a special case. And so none of our clients, as yet, will be ordering or building facilities of 200,000 orders plus. So we're going into the unknown, as it were, in terms of growth from here. So I think a reasonable assumption is to take 70,000 in 18 months and project forward at that rate. And if you do the math properly, by the end of next year, we're talking of adding, well, approximately, call it, 40,000 per week as a reasonable assumption. So that will be a way of looking at it.With U.K. grocery market, I don't think there's anything in particular for us to comment because we're clearly growing double. Unlike the rest of the industry, our focus is less on the 0.1% and the 0.5% growth, which is driven by those macro trends, and we have 55,000 products. So we have much broader products with a lot of impacts in our earnings. So we're not seeing any particular market impacts to our range. We're just seeing the benefits of channel shifts happening.

[Robert Joyce, Equity Analyst]

Okay. On the food inflation side, are you seeing any changes?

[Duncan Tatton-Brown]

Not really, Rob, nothing notable across -- again, across -- we're talking 55,000 products here. So no, not a noticeable trend that I would call out.

[Operator]

The next question is from James Grzinic, Jefferies.

[James Robert Grzinic, Equity Analyst]

Just a very quick one, actually, Duncan. Can you perhaps provide more details as to this additional GBP 25 million in operating costs you pointed out for next year a couple of weeks ago. I'm just wondering what the split, how Japan fits within that, and more specifically, what the potential would be great.

[Duncan Tatton-Brown]

James, that's more of a question for the year-end. But just to give you some tidbits now, and you can ask that question again at the year-end, I did mention 400 extra people in technology. That gives you a sense. You can work out that annualized cost for them. And that will give you a sense and that's probably the biggest single element of it. The second group is general overhead costs for the scaling that we're seeing with our customers. So whether that be from a finance team, to HR team, to legal teams, to program management. And then there's clearly some specifics in that for Japan, Aeon specifically. But that's actually the smallest part of that. This is just a confidence around how we're growing our business and expect to continue growing our business.

[James Robert Grzinic, Equity Analyst]

So essentially, the rates of growth exceeds what you expect there? So you're growing the fixed costs ahead of what you thought to deliver that?

[Duncan Tatton-Brown]

Yes. I mean we didn't envisage in our original plans to sign up with this many clients with this much capacity in this time scale, so we're going ahead of plan.

[Operator]

There are no further questions. Now I would like to hand back to you, gentlemen.

[David M. Shriver, Communications Director]

Very good. Well, thank you very much, indeed, ladies and gentlemen. That concludes our Q4 trading call. We'll meet going formally for an IFRS 16 and an accounting update on the 22nd of January. And then, again, of course, the FY results on the 11th of February 2020. In the meantime, enjoy the festive season and have a very good day. Thanks very much.

[Operator]

Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.