Outlook for Ocado shares in 2021

Ocado shares have been among the best performing shares on the FTSE 100 in 2020. They have been hot property for most of the year, but they have come under a bit of investor scrutiny recently. Are they a must buy?

Ocado shares overview

Performance & deliveries

At the time of writing the Ocado share price has risen 80.45% year-on-year. Seemingly 2020 was made for the grocery delivery business, with lockdowns and travel restrictions forcing more consumers to stay at home and shop online.

On December 17th 2020, the share price was 2,230.50p – down some 20% from their all-time highs struck at the end of September. Ocado’s revised market cap as of December 2020 is £16.69bn.

In September, the company’s valuation hit a record $21.7bn, making it the most expensive UK retailer, larger than fellow grocer Tesco. But this was not due to grocery sales. Ocado controls just 1.7% of the market. Comparatively, Tesco controls 26.8% of food & drink retail sector as the market leader.

Ocado made 345,000 deliveries in the quarter leading up to the August 2020. Compared with Tesco, which is now offering 1.5m weekly deliveries, Ocado’s performance is not spectacular on the deliveries front.

Even so, the Ocado share price is probably reacting more to its growth in revenue. In Q3 2020, its grocery revenues were up 52%, showing significant acceleration from the 27% forecast in H1, although this fell to 35% in the final quarter of 2020. As we have talked about before, investors seem to be more prepared to stump up for companies with a strong growth profile over those with strong free cash flow.

A swap from Waitrose to Marks & Spencer as its main food partner has helped grow retail sales too, as Marks is encouraging larger baskets for Ocado shoppers.

This is still lower in real terms than Ocado’s larger competitors. 2020’s unique conditions have meant all the major supermarket chains have had to invest in their own online businesses. Tesco’s online sales were up 69% in the six months to 29 August. Sainsbury’s recorded a 75% rise in the three months to 27 June. Competition is fierce.

Technology & deals

The technology side of the business is the main driver behind Ocado share price growth. Its technology-led operations mean its online business is more profitable than its rivals who try and keep eCommerce prices as close to bricks-and-mortar equivalents as possible.

Digital retail incurs further costs, like salaries for pickers and warehouse operatives, fuel and maintenance for delivery vehicles, and so on. However, Ocado’s proprietary warehouse automation tech allows it to operate its fulfilment centres in a more efficient manner than its competitors. The company estimates its revenues will grow 70% overall thanks to its technological approach.

Its tech business is also a source of interest for investors because it can be sold to other supermarket chains at home and abroad. For instance, Ocado has licensed its technology to Morrison’s, although Morrison’s has chosen to partner with Amazon and Deliveroo to deliver its food.

That said, Ocado has struck tech supply deals and CFCs with companies like Coles in Australia and Kroger in the US. In fact, Ocado shares rose 44% following the signing of the Kroger deal in March 2019. This, however, should be tempered by fact Ocado has not inked a fresh technology supply deal for over a year.

It is, however, burning cash to grow this side of the business. In November 2020, it spent $200m acquiring Las Vegas-based robot technology firm Kindred Systems. This could give Ocado a bigger foothold away from grocery retail and into automation tech, but it is a gamble when it comes to generating higher returns.

One cause for investor concern though is the payback timeframe from all Ocado’s foreign deals. This is taking a long time to materialise and could have an impact on share prices going forward.

Expansion and growth will also play on investors’ minds. Even with in-house tech, this is not a cheap, quick process. Ocado has said it has plans to expand its business by 40% in 2021, but this will incur costs in real estate and staff.

Outlook for Ocado share price

The outlook is mixed. The Ocado share price has dropped from its year high of 2,911.00p. Uncertainty as to the viability of its technology licensing business may cause an investor wobble due to changing the company’s original food delivery mission statement.

Covid-19 will also play a big role. Vaccine rollout across the UK has begun, but it’s likely that full vaccination won’t happen until at least the autumn/winter of 2021. Several areas in the UK are also back in Tier 3 classification – the highest current level of lockdown rules – as cases mount. Will that play into higher online grocery shopping? And will shoppers necessarily turn to Ocado?

2021 could prove to be a decisive year for the food delivery business.