Ocado - Waiting on delivery.
All,
Please find our slightly amended analysis here.
We expect to take a long position, once the weak H1 results have been digested by the market. Bond yields are now near 13%, meeting our initial risk-reward target. However, our hurdle rate is a moving target, because real estate yields are rising and this impacts both, our required return, and the cost of capital and development for Ocado. The company and the bonds are long duration (low current RE earnings vs. future developments is a profile matched by low coupon/ long maturity bonds), so there is risk from costs and interest rates moving higher over the next few months. We believe in the shift to online shopping and the model adopted by Ocado. Ocado will need to tap the markets for some debt before it is free cash flow positive, but this will be at a time the profitability of the concept will have been established. Q1 trading statement is as short in detail as we expected, but it confirmed that the beginning of the green shoots seen in December has continued. Our model reflected a second-half recovery: but we have adjusted H1 EBITDA and capex to reflect timing. We expect the trajectory for results to be upward from H2.
Investment Rationale:
- The SUNS currently yield nearly 13%, close to where we see returns matching risk, although this target has also just moved out. Revenue and profitability will begin to rise in the 2nd half of FY22/23. H1 numbers are due out on the 18th of July, and we will look to take advantage of the expected weakness in the immediate aftermath. Probably the lowest dollar, longest duration paper.
- We see the outstanding SUNs/Converts approx. 50/50 covered by the values of the 50% stake in the Ocado Retail business and the Technology Business respectively. The former is going through a tough market and the latter is still very much an equity story, offering primarily option value. But Ocado is an attractive, growing company with a first-mover advantage that is an asset of its own today (albeit depreciating and to be replaced with the value from growing cash flows). Investing in SUNs feels like venture capital, which makes an interesting diversification to our book.
2023 will be the trough cashflow-wise, if weak operationally:
- Headwinds from the cost-of-living crisis and the unwind of some of the COVID high tide in online grocery shopping have hurt profitability in the Retail JV (with M&S). EBITDA fell from £150m to -£4m in FYE Nov-22. H2 will improve, although we expect negative EBITDA at the group level for the full year.
- Free Cash flow in 2023 will be -£780m but that will drop significantly after that as significant fee revenue begins to flow from the Technology business.
£500m Further cash is needed but attainable:
- Further cash is needed in 2025, the shortfall in 2024 could be managed via working capital management and capex timing.
- In December 25 and October 26, £1.1bn of debt will need refinancing. BT FYE Nov 25, we expect Ocado to be able to show leverage heading to <5x during the following year. A jumbo deal to refinance the Converts/SUNs and the additional cash needed would represent 2.8x 2026 EBITDA (or 4.7x 2025 EBITDA).
- We like the business plan assets, and we see the balance sheet as having the flexibility to support the debt needed to deliver it.
I look forward to discussing this with you all.
T: +44 203 744 7055