Ocado Has Been Demoted From The FTSE 100. Should I Buy its Shares?

Key
Morningstar
Metrics
for
Ocado 

• Fair
Value
Estimate: £9.20;
• Morningstar
Rating:
★★★★★;
• Morningstar Economic
Moat
Rating:
N/A;
• Morningstar
Uncertainty Rating:
Very
High.

Why
Has
Ocado
Been
Demoted
From
The
FTSE
100?

At
a
market
capitalization
just
under
£3
billion,
it’s
no
longer
valuable
enough
to
make
the
cut.
Ocado
shares
currently
trade
at
£3.53,
compared
to
a
£28
peak
at
the
height
of
the
pandemic.
So
far
in
2024,
they
have
fallen
a
whopping
52.18%.
The
numbers
also
look
negative
over
longer
time
periods.
Over
three
and
five
years
to
5
June
2024,
shares
have
dived
81.2%
and
68.2%,
respectively.

“This
underperformance
is
due
to
intense
competition
in
the
UK
grocery
market
and
a
cost-of-living
crisis,
which
traditional
brick-and-mortar
supermarkets
were
able
to
manage
more
effectively,”
Morningstar
director
of
equity
research
Ioannis
Pontikis
says.

The
resulting
falls
in
Ocado’s
share
price
mean
that
its
market
capitalisation
(the
value
of
its
shares
multiplied
by
the
number
of
shares
on
issue
for
sale
and
purchase)
robs
it
of
its
status
as
one
of
the
UK’s
100
biggest
companies.

Ocado
has
been
slow
to
make
good
on
proposed
business
deals.
The
biggest
of
its
tie-ups
–
with
premium
clothes
retailer
and
food
distributor
Marks
&
Spencer
(MKS) –
appears
to
be
benefiting
the
latter
more
than
the
former.
Over
the
last
12
months,
shares
in
M&S
are
up
over
65%
to £31.00.

The
pair
is
also
yet
to
agree
on
the
final
payment
M&S
owes
for
its
50%
stake
in
Ocado
Retail,
which
it
bought
in
2019.
M&S
has
argued
it
should
not
pay
the
remaining £190
million
it
originally
owed
Ocado
because
the
business
has
not
hit
certain
performance
targets.
Ocado
chief
executive
Tim
Steiner
is
now
threatening
legal
action.

Twin
headwinds
of
a
cost
of
living
crisis
and
the
return
to
normal
shopping
have
weighed
on
Ocado’s
prospects.
After
peaking
at
14%
of
all
shopping
activity
in
2021,
online
ordering
has
since
reverted
to
its
pre-pandemic
norms
of
11%
of
market.

Fair
Value
Estimate
for
Ocado

Assigning
it
a
5-Star
Rating,
Pontikis
says
Ocado
is
significantly
undervalued
and
represents
a
buying
opportunity
for
those
willing
to
keep
the
faith
in
the
power
of
technology,
and
specifically
its
proprietary
product:
Ocado
Smart
Platform,
a
white-label
technology
business
that
offers
AI
and
robotics
central
to
other
firms’
logistics
models.

“Our
constructive
view
on
the
stock
is
supported
by
our
thesis
that
the
Ocado
Smart
Platform
is
a
leading
provider
of
online
grocery
fulfilment
solutions
for
large
brick-and-mortar
grocers,
especially
as
online
penetration
grows
in
developed
markets,”
he
says.

He
also
views
Ocado’s
experience
in
the
underlying
economics
of
customer
fulfilment
centers
as
a
major
tailwind
for
profitability.
Global
opportunities
and
further
tie-ups
also
validate
a
generous
Fair
Value
Estimate
of £9.20,
he
adds. 

“Our
valuation
reflects
online
penetration
rising
to
25%
by
2040
in
developed
economies
with
Ocado’s
solutions
capturing
a
high
single-digit
market
share
in
these
digital
grocery
markets
through
Ocado’s
partners.”

Economic
Moat

But
there
are
also
risks.
Because
of
the
nature
of
its
business
and
the
extremely
competitive
groceries
market
it
operates
in,
Ocado
does
not
earn
a
Morningstar
Economic
Moat
Rating.
What’s
more,
Ocado’s
“Solutions”
business
is
still
at
an
early
stage
of
development,
is
capital-intensive,
and
faces
major
execution
risks. 

As
additional
partners
join
Ocado’s
platform,
a
strengthening
of
intangible
assets,
switching
costs,
and
cost
benefits
may
emerge.
These
may
be
enough
to
warrant
an
upgrade,
which
would
give
Ocado
a
“Narrow”
Economic
Moat
Rating –
indicative
of
it
being
able
to
fend
off
competition
for
several
years.
Investments
in
its
proprietary
technology
platforms
could
also
lead
to
an
increase
in
customer
loyalty,
and
a
network
effect
once
more
partnerships
materialise.

Risk
and
Uncertainty

Given
this
situation,
Pontikis
assigns
Ocado
shares
an
Uncertainty
Rating
of
Very
High.
For
one,
Ocado
faces
intense
competition
in
the
UK
as
grocers
battle
to
earn
the
loyalty
of
customers
with
squeezed
budgets.
Tesco’s
“price
match”
has
resulted
in
significant
price
reductions
over
the
past
few
years,
and
that
has
hit
Ocado
disproportionately
because
it
doesn’t
have
the
purchasing
power
its
older
(and
larger)
peers
do.

Although
Ocado’s
solutions
business
is
the
clear
driving
force
and
top
focus
moving
ahead,
the
market
for
this
kind
of
innovation
is
currently
modest,
which
means
it
will
take
Ocado
time
to
scale. Morningstar
analysts
also
expect
stickier
inflation
to
have
a
greater
impact
on
the
business,
given
its
exposure
to
shrinking
baskets
and
added
delivery
costs
per
order. 

These
risks
are
not
domestic
either.
The
firm
also
risks
failing
to
successfully
commercialise
its
solutions
technology
overseas
due
to
service
disruptions,
quality
issues,
or
slow
online
adoption
growth.
While
the
likelihood
is
low,
the
effect
would
be
“catastrophic”,
Pontikis
says. 

Ocado
Bulls
Say

Ocado’s
Smart
Platform
is
one
of
the
most
efficient
and
reliable
end-to-end
online
fulfilment
solutions
for
the
grocery
market
today; 

Ocado’s
global
opportunity
is
significant,
and
is
driven
by
the
further
potential
of
online
penetration
in
the
grocery
market;

OSP
is
the
result
of
Ocado’s
relentless
focus
on
solving
the
online
grocery
riddle
through
cutting-edge
proprietary
technology
that
is
hard
to
replicate.

Ocado
Bears
Say  

There
is
considerable
execution
risk
involved
in
rolling
out
committed
customer
fulfilment
centres
(CFCs)
for
partners/grocers
over
the
next
few
years.

Ocado’s
solution
is
significantly
more
capital-intensive
than
alternatives
(for
example
microfulfilment)
with
longer
payback
timetables.

There
are
considerable
financing
challenges
ahead
for
Ocado
as
it
rolls
out
its
partners’
CFC
network.
That
exposes
it
to
external
factors,
including
interest
rates
and
the
price
of
debt.

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