‘More Marks & Spencer magic should help Ocado sparkle’

Three years ago, Ocado’s market capitalisation of £23bn exceeded that of Marks & Spencer, Morrisons and Sainsbury’s combined, as the Covid-19 outbreak took hold and there was a massive switch to online shopping.

Now, it is valued at £5bn and a recent share price rise owed more to speculation that Amazon was poised to snap up Ocado, rather than any belief in the intrinsic merits of its digital know-how and grocery business – a joint venture with Marks & Spencer.

As pandemic conditions receded, Ocado Retail’s profits evaporated. Although they believe in the long-term prospects, M&S bosses have signalled their disappointment with the pureplay grocer’s performance – most recently at the M&S AGM when chair Archie Norman acknowledged there was “work to do”.

“Ocado’s travails come at a time of broader questions about the future growth of online grocery”

That work must be partly shouldered by M&S. It is a shareholder, with a 50% stake, rather than simply a supplier of products. There is an onus on M&S to do what it can to improve performance at Ocado, which has contributed to the transformation of M&S by making its food available online in a big way for the first time.

Ocado’s challenge boils down to an inability to make enough money to cover its high operating costs, which meant last year that EBITDA plummeted into the red by £4m from a profit of £150.4m the previous year. Order and customer numbers have been on the up, which is good news, but basket values have been flat and basket sizes have slumped, according to Ocado Retail’s separately reported first-quarter update.

Ocado Retail is in the midst of a “perfect execution” strategy driven by chief executive Hannah Gibson and there are some encouraging signs. EBITDA is expected to be “positive in the second half as a return to volume growth supports improved capacity utilisation and reduced costs relative to sales”.

Mutual benefits

M&S can surely be key to that volume growth. The more of its products carried by Ocado, the better Ocado will do as it benefits from its ties with one of the best food retailers in the country, famous for its quality and possessing increasing authority in value – something Ocado was slow off the mark on as rising prices squeezed consumers.

More M&S products being sold on Ocado should in itself enhance its appeal. The association might also help bring down Ocado Retail’s high marketing spend – up 42.9% last year to £57.6m. A link to Ocado from the food section on M&S’ website would be a start.

Ocado’s travails come at a time of broader questions about the future growth of online grocery. Although Amazon has been mentioned of as a potential buyer of Ocado, there has been no move and there seems little reason to think there should be one now. Amazon’s own push into food has not disrupted the established grocers to the extent that was once predicted.

“Other pureplay retailers that have been through the mill, such as AO, have righted the ship by focusing on profitability and shown they can adapt”

This week, high-profile investor Terry Smith told shareholders that his Fundsmith business had got rid of Amazon shares because of worries about its grocery business, which Smith sees as at odds with the business principles set out by Amazon boss Andy Jassy such as the level of return on investment.

Smith explained: “Where companies choose to invest outside a powerful core franchise in which they already have expertise, we believe they are likely to destroy value and especially so where they are entering a sector which already has poor returns.”

For M&S, a latecomer to online food retail, the team-up with Ocado still makes sense as long as it can get volumes moving and turbocharge the M&S range on the site. Other pureplay retailers that have been through the mill, such as AO, have righted the ship by focusing on profitability and shown they can adapt to changing trading conditions. 

For Ocado Retail, the more M&S food magic and sparkle that can be brought onboard, the better.