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Ocado advised to abandon new £210m Warwickshire centre

Ocado has been under pressure recently on worries about its growth prospects and increased competition, not least from its current partner Waitrose.

It is also spending more money on its Hatfield customer fulfillment centre, and building a second such depot in Warwickshire. But analyst Clive Black at Shore Capital believes this expansion could be a mistake, and said Ocado would do better to abandon its plan for Warwickshire until Hatfield has proven its worth. In a sell note Black – a notable critic of the company since last year’s flotation – said if it did not, and trading continued to be tough, it could be in need of more cash in a couple of years. He said:

Shore Capital has been concerned about the Ocado business model for some time. These concerns were a key part of why we did not believe that the business deserved what we deemed to be inflated stock valuation metrics, metrics that are showing signs now of easing back to some form of relationship with ‘financial’ Planet Earth. Whilst all this is so, Ocado stock still does not represent good value to our minds.

Indeed, it remains our belief that Ocado should prove that it has a viable business with [Hatfield] and mothball/adjust its plans for [a second depot] until this time is reached. Otherwise, although the business does not need additional capital to survive just now, it may do so sooner than many of the ‘Ocadophiles’ think.
We believe management should therefore focus on Hatfield, demonstrate that its rhetoric has meaning and seek to build thereafter. However, we do not believe management will follow this course of action and so we retain our long-standing sell recommendation.

Offering a Plan B for Ocado, Black said the company should mothball the £210m Warwickshire depot and £80m expansion at Hatfield to save cash, even though contractors are already on site. Indeed, if it wants another depot, it should build it south of the M25 to fulfill its view that premium online grocery performs more strongly in the south of the country. But it should spend a lot less on the project, perhaps £70m. Black said:

We struggle to see how Ocado can spend [nearly £300m] on its proposed [depots] and deliver a satisfactory return. We believe there may be considerable merit in Ocado stepping back and reappraising, seeking to conserve cash, reduce capital intensity and build profitability and so returns. That is our proposed carrot.

However, there is a stick too. We worry about the trading momentum of Ocado and the sustained downgrades to earnings in the space of just one year. Why should this trend end now? Surely the potential for more downgrades remains a live issue? We worry about the cash burn at Ocado and what this may mean for the group if Warwickshire takes time to commission and so deplete margins and returns further.

At the moment Ocado shares have edged up 1.8p to 115.4p. © Guardian News & Media Limited 2011 | Use of this content is subject to our Terms & Conditions | More Feeds