Financial Analysis Coursework April 2016 - Ocado

01 April 2016
Ocado Group PLC
Fundamental Research
NUBSFinancial
Company fundamentals
Share price history
UK grocery sector
BUY
Source: IGD UK
Source: Google Finance
www.NUBSFinancial.com
Ocado is the UK’s major online-only grocery retailer with a
business model that integrates online grocery sales with
the development and commercialisation of intellectual
property (IP) and technology used in a retail environment.
Beta: 1.74
Net Income: £11.8m
Current Share Price: 345p
1 Year Change:6.69% ↓
Source: Google Finance
LSE: OCDO:LN
Web: ww.ocadogroup.com
CEO: Tim Steiner
CFO: Duncan T-Brown
Shares: 590.04m
Market Cap: £2.04bn
Growth: 1.7%
Worth: £117.bn
Contents:
1. Industry Analysis
a. 1.1 Porter’s 5 Forces
b. 1.2 PESTEL
c. 1.3 SWOT/Strategy Analysis
2. Accounting Analysis
a. 2.1 Accounting Policies
3. Financial Analysis
a. 3.1 Profitability
b. 3.2 ROE and DuPont
c. 3.3 Liquidity
d. 3.4 Debt
e. 3.5 Z-Score
4. Forecasting
a. 4.1 Assumptions
b. 4.2 Forecasts
5. Valuation
a. 5.1 Residual Income
b. 5.2 Multiples
6. Conclusion
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www.NUBSFinancial.com April 1, 2016
OCADO GROUP PLC FTSE: (OCDO)
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Industry Analysis

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Existing rivalry
Industry stagnating
The industry’s annual growth rate has fallen from 4.3% (2010) to 1.7% (2015) (IGD, 2015) with year-
on-year decline since 2012. Although the 12-week growth up to March 2016 was 0.5% (McKevitt,
2016a), a Christmas mini-price war has put pressure on retailers (Felsted, 2016a) that could threaten
industry progress. While grocery
retailing is stagnating, online retailing
purports significant customer growth
of 29.0% for the 52-weeks up to April
2016 (Mintel.com, 2016), in addition
to the rise of discounters Lidl and
Aldi whose cumulative market share
is up to 10.7% (Felsted, 2016b) from
5.0% in 2011. This indicates a shift in consumer preferences towards low cost products, due to
austerity measures post-financial crisis, and accommodation for hectic modern lifestyles.
Industry increasingly fragmented
Discount retailers Aldi and Lidl have fragmented the industry by utilising their low-cost model to
undercut rivals, making it more difficult for supermarket giants to coordinate pricing strategies.
Industry-wide price deflation has persisted, shown in Figure 1, with the average shopping basket
down 2.1% on last year (McKevitt, 2016b) and
further cuts expected with Tesco slashing 25%
on 380 items, Morrison’s targeting £1bln of
cuts over the next three years, Sainsbury’s
slashing prices by £50m, and Asda aiming to
narrow its own-brand price gap to within 5% of
Aldi’s (Canocchi, 2016; Butler, 2015). Online
retailing is seeing more competition, with Sainsbury’s seeing year-on-year online sales increases
(Vandevelde, 2016a), Waitrose a 31% rise in online grocery sales (John Lewis, 2015) and the
introduction of Amazon Pantry (Weinger, 2015). Ocado’s competitive advantage - through advanced
robotics and proprietary IP - looks set to be challenged by the supply and logistics expertise of
Amazon. Discounters Aldi and Lidl have yet to move online, but Aldi have seen success with their
wine and non-food website (Butler and Farrell, 2015a), adding more competition to online retailing.
Figure 2 – Food Deflation (Locket, 2015)
Figure 1 – Market Share (Kantarworldpanel.com, 2015)

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Products undifferentiated and switching costs negligible
Supermarkets offer broadly undifferentiated products through widely-offered branded items and
near-substitutes in own-brand ranges. The proliferation of discounters indicates the price sensitivity
of the average consumer and limited customer loyalty to established chains. Those with customer
loyalty schemes – most prevalent of which are Tesco and Sainsbury’s – hope to lock-in consumers,
but falling rewards (Cook, 2016) coupled with the shift in consumer preferences are dampening their
influence. Switching grocers entails no additional costs, with supermarket’s charging similar delivery
fees that are independent of the distance travelled and stores being easily accessible – with London
having on average 1.1 stores per square kilometre (Barrett, 2015) - making it straightforward for
customers to switch. In 2015, 24% of all British shoppers switched (Perrett, 2015). The ease of
switching incentivises price competition, adding to price deflation and ensuing price wars.
Entrants
Scale economies and substantial capital requirements
Big 4 supermarkets have significant advantages in terms of economies of scope and scale, brand
awareness, provision of services and large capital reserves. All-time high short positions on grocery
stocks (Colvin, 2015) indicates low investor confidence in the industry, which will make it difficult for
new entrants to obtain funding on the scale necessary to compete with the supermarket giants. This,
compounded by capital requirements and scale economies, act as a significant barrier for new firms.
Land hoarding
The 2000s saw large land hoarding from supermarkets (Goodley and Haddou, 2014) so as to prevent
rivals operating close to existing stores in profitable regions, acting as a barrier to entry. Despite the
Land Agreements Exclusion Revocation Order from the Competition Commission, hoarding is still an
issue, with Tesco currently being sued for anti-competitive behaviour (Armstrong, 2016).
Substitutes
Independent food shops
Despite the retreat of butchers, fishmongers and greengrocers across Britain, London has seen an
emergence of high-end independent grocers (Jack, 2014) that stock organic and ethically sourced
products. Whilst these establishments will attract ethical consumers who may otherwise frequent
more up-market supermarkets, their decline indicates little threat of substitutes.

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Suppliers
Minimal bargaining power
The relative size of supermarkets to their suppliers enables them to exercise significant power in
securing favourable contractual terms, but bullying tactics employed by supermarkets (Competition
Commission, 2008) have resulted in a new industry code, the Groceries Supply Code of Practice (BIS,
2009) to curtail this influence. The Groceries Code Adjudicator has investigated Tesco for non-
compliance (Butler and Farrell, 2015b) but financial distress is persisting among suppliers, with a
92% increase as a consequence of the price war with discount retailers (Palmer, 2015). This
indicates both minimal bargaining power but also little protection afforded by the GCA, and as such
fresh regulation may be introduced to give the GCA greater powers to protect suppliers.
Buyers
Significant collective power
Consumers exhibit significant power due to the lack of differentiation and low switching costs. Their
power has been augmented as a consequence of the increasing fragmentation of the market, with
discounters offering low-cost alternatives. Grocery retail accounts for 51.3p in every £1 of UK retail
sales (IGD, 2016) indicating its significance in consumers’ cost structures. Price comparison websites
further add to consumers buying power, as well as price matching utilised by many supermarkets.
Political and Legal - Taxation, ‘Brexit’ and accounting framework
Ocado operates in a stable UK marketplace, where we expect to see corporation tax reduced to 19%
(2017) and 18% (2020) (Gov.uk, 2015), which will help strengthen cash flow over the coming years.
Ocado’s strategy of internationalising may be hindered, however, as uncertainty over Britain’s exit
from the EU presents fresh challenges in securing international partners for the Smart Platform.
Adjustments to IFRS 15, Revenue Recognition, (Ias.com, 2015) could impact positively or negatively
on Ocado’s income statement as customer contracts and performance obligations are altered.
Environmental - Bag disposal and carbon footprint
Consumers are increasingly informed about and concerned with companies’ corporate social
responsibility. Ocado is a natural beneficiary of this, with their business model centred on minimising
stores. Despite this, major fuel use through delivery could deter customers, although news reports
suggest that Ocado is investing in electric vans (Van Fleetworld, 2016). Ocado also offers customers
5p for every bag recycled (Ocadogroup.com, 2016), which customers should view favourably.

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Strengths – online retail solutions and advanced systems
The commercialisation of Ocado’s IP has led to the creation of the Smart Platform, the “most
advanced end-to-end online solution” (Ocado, 2016), as a move away from the previously single-
minded focus of online grocery operation. The Smart Platform benefits from cost leadership in the
key grocery cost drivers of people, property, waste and energy, with their systems, processes and
hardware having been developed in a live retail environment (Ocado, 2016). Ocado have seen
accelerating delivery rates of units per man-hour that are currently at 153 and are expected to hit
180, in comparison with most other supermarkets struggling to reach 80 (Ford, 2015), indicating
more advanced and efficient systems compared to competitors. These key competencies – simplicity
of supply-chain, advanced operating systems and technological expertise – give Ocado a competitive
advantage in the online environment as they centrally coordinate and automate picking of groceries.
Weaknesses – narrow consumer focus
Tesco, Sainsbury’s and Asda operate strategies with provision of services and a complete shopping
experience at their heart (Tesco, 2015; Sainsbury’s 2015; Walmart, 2015), contrasted to Ocado’s
online-only focus. Their lack of presence physically may be cost-efficient, but ensures they lose out
to more casual shoppers and do not capitalise on footfall patterns and localised shopping trends.
Opportunities – commercialisation of IP and internationalisation
Ocado’s IP is fundamental to their strategy, and their advancements in robotics are lauded by the
industry (Twentyman, 2015). To maintain its current competitive advantage and prepare for
Amazon’s entry, Ocado is seeking funding on a pan-European robotics project, funded by the EU
(Vandevelde, 2016). The expansion of operations to include the more-efficient Customer Fulfilment
Centres (CFCs) 3 & 4 gives Ocado the ability to accommodate any global partner or sales expansions.
Threats – increasing competition and dual business model
The entrance of Amazon Pantry, with their deal to sell Morrison’s own-brand products (Vandevelde,
2016), puts pressure on Ocado due to the strong financial power, economies of scale and scope of
Amazon, as well as their own sophisticated technology. This puts them in an ideal place to make
short-to-medium-term losses in order to capture market share. The question still remains as to
whether Ocado can continue with its dual business model of grocer and technology firm, with
Director of Technology, Paul Clarke, stating “[w]e are morphing Ocado to become the fusion of a
technology business, a retailer and a platform business” (Clarke, 2015 cited in Twentyman, 2015)
whilst Director of retail consultancy firm Retail Vision, John Ibbotson, stated “the status quo will
eventually become untenable” (Ibbotson, 2016 cited in Thomas and Brown, 2016).

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02
Accounting Analysis

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Capitalisation of software costs – executive remuneration risk
The Group pursues a policy of capitalising costs relating to the development of proprietary software,
including CFC equipment, the asset fulfilment solution and Smart Platform (Ocado, 2016). More
specifically, rather than expensing costs as operational in the current period, an intangible asset is
recognised and amortised over subsequent periods. In consequence, the Group’s EBITDA is inflamed
for the period which, in turn, lowers the quality of this key financial metric. For FY15, the Group
recognised £24.1m of internal development costs, an increase of 39.3% (£17.3m) from FY14 and
59.6% (£15.1m) from FY13 (Ocado, 2016). Despite the discretion offered by IAS38, the Audit
Committee – headed by independent non-executive director Ruth Anderson, who also chairs three
other audit committees of listed UK companies – has reported judgements to be reasonable and
amounts not materially sensitive (Ocado, 2016), and such an increase is justifiable considering the
Group’s strategy of developing intellectual property.
What is concerning, however, is the Group’s executive director ‘Annual Incentive Plan’ (AIP) being
based primarily upon EBITDA, with total AIP increasing by 22.2% this year (Ocado, 2016). We thus
believe, in contrast to EBITDA, EBIT should be used as the future performance measurement metric.
Depreciation and Amortisation – less aggressive
Ocado, like its competitors, adopts a straight-line depreciation and amortisation approach (Ocado,
2016; Sainsbury’s 2015; Tesco, 2015). The useful life of freehold buildings and leasehold properties
set by Ocado is 25 years (Ocado, 2016), which is significantly lower than the useful life used by
Tesco, 40 years, (Tesco, 2015) and Sainsbury, 50 years, (Sainsbury, 2015), indicating a less aggressive
depreciation and amortisation policy relative to competitors. Total depreciation and amortisation
costs have increased year-on-year and were £60.1m at FY15, an increase of 9.3% from the year
before, reflecting the Group’s strategy of domestic and international expansion as they look to
increase the number of CFC’s and vans in order to attract and accommodate further partnerships.
Supplier volume rebates – estimates and judgements
Volume-related rebates are listed as one of the three facets of commercial income, calculated based
on estimations of meeting volume-related targets included in annual agreements with suppliers
throughout the year (Ocado, 2016). The Audit Committee report that these rebates are of a material
amount and are satisfied with managerial judgement for the policy (Ocado, 2016), but such rebates
were an integral part of Tesco’s profit overstatement in 2014 (Barrett et al., 2014) and require

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significant estimations and judgements in order to recognise the income on an accruals basis, and
therefore in the period incurred. The Auditors Report outlines commercial income and volume
rebates as areas of focus due to the subjectivity of estimations, with volume rebates the area that
“involves the most judgement” (Ocado, 2016: p121). PwC, the auditing firm, addressed this by
assessing the historical accuracy of estimates, gaining direct confirmation for accrued amounts from
suppliers and re-performing calculations based on invoiced amounts (Ocado, 2016). PwC highlighted
volume rebates as a risk with significant estimation and assumption, but assurance given through
testing does not mitigate the risk involved when recognising such forms of commercial income.
Fixed asset level – cost-and energy-efficient
The table below highlights Ocado’s fundamentally variable cost based business model, with PPE
turnover at 3.38 - 0.91 and 0.4 better than Sainsbury’s and Tesco’s, respectively, (FAME, 2016). Not
only does this highlight the Group’s cost efficiency in sales, but it also recognises their strategic
commitment to becoming “the UK’s most sustainable and environmentally friendly supermarket”
(Ocado, 2016). Unlike other competitors, the Group’s business model does not rely on physical
stores generating excessive emissions and waste (Ocado, 2016), and as such this acts as a key
competitive advantage in a targeted strategy to attract ethically and sustainably driven consumers.
FY15 Ocado Tesco's Sainsbury’s
Sales (£m) 1,107.60 54,433.00 23,775.00
PPE (£m) 327.30 17,900.00 9,648.00
PPE Turnover 3.38 3.04 2.46
Table 1 – PPE Turnover

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03
Financial Analysis

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Profitability
While a shopping basket costs 2.1% less a year ago (Uk.kantar.com, 2016) - causing gross profit
margins among industry peers to decline from 10.61% to 8.18% - Ocado’s gross profit margin has
increased steadily, driven by the Morrison’s joint venture and the subsequent growth of Morrison’s
online sales from £45.1m FY14 to £73.7m FY15 (Ocado, 2016). This can also be attributed to a 30%
rise in Ocado’s customer base (Brinded, 2016), which is underpinned by broadening customer
demographics (This Is Money, 2015) and a significant expansion in their product range by 26% in
2015 (Thegrocer.co.uk, 2015). Ocado also predominately sells branded produce, as opposed to own-
label, where margins are higher (Palepu et al., 2013). Despite this healthy gross profit margin,
distribution and administration expenses - which include picking and delivery costs for both Ocado’s
and Morrison’s operations as well as costs to enable the Group to develop the Smart Platform - have
risen, with them up 19.8% this year (Ocado, 2016). Although EBIT and net profit margins have risen,
they remain sluggish relative to gross profit margin. While Ocado could be enhancing their net profit,
they continue to invest heavily in the Smart Platform, which makes us again question whether to
classify them as a technology or supermarket company. It also concerns us that, despite growth,
costs are seeing higher increases, suggesting Ocado is not realising any scale economies (Fool, 2016).
Industry peers FY12 FY13 FY14 FY15
Gross Profit Margin 10.61% 10.39% 10.56% 8.18%
EBIT Margin 4.76% 4.11% 3.53% -1.52%
Net Profit Margin 3.03% 2.27% 1.73% -2.11%
Table 3 – Industry peers’ average profitability ratios
Return on Equity
Table 4 displays ROE for Ocado, its industry peers and the industry average from FY12 to FY15. While
hostile conditions have affected the larger retailers - leading to negative ROE at Tesco’s, Sainsbury’s
and Morrison’s - Ocado’s ROE has risen from -1.17% to 4.88% - significantly above the average.
Ocado FY12 FY13 FY14 FY15
Gross Profit Margin 30.55% 31.25% 32.98% 33.87%
EBIT Margin 0.50% -0.29% 1.76% 1.95%
Net Profit Margin -0.35% -1.58% 0.77% 1.07%
-2.00%
-1.00%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
FY12 FY13 FY14 FY15
Ocado
Industry
peers
Graph 1 -EBIT Margin FY12 to FY15
Table 2 – Ocado profitability ratios

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ROE Ocado
Group PLC
Tesco
Group PLC
J
Sainsbury
Morrison
PLC
Waitrose
Limited
Aldi
Limited
Other
peers av.
FY15 4.88% -81.19% -3.00% -21.17% 6.80% 9.86% -17.74%
FY14 3.35% 6.62% 11.93% -5.07% 10.88% 10.85% 7.04%
FY13 -6.18% 0.75% 10.71% 12.37% 8.62% 6.97% 7.88%
FY12 -1.17% 15.79% 10.62% 12.78% 9.16% 3.81% 10.43%
Table4 – Return on Equity (net profit/equity)
DuPont Analysis and Operational
We extend our ROE evaluation by utilising DuPont analysis. Ocado’s increase in ROE can be credited
to an improvement in asset turnover and, to a lesser extent, net profit margin. Asset turnover has
increased from 151.37% at FY12 to 187.22% at FY15 – a rise of 23% that outstrips the 9% increase
seen across the industry indicating superior operational performance. This can be attributed to the
Morrison’s joint venture and the simultaneous development of its second distribution centre in
Bury, Lancashire, which has over seven times the asset turnover compared to a traditional grocer
(Fletcher, 2013). This has further extended Ocado’s capital advantage over store-based incumbents,
and this efficiency will enable Ocado to operate at thinner margins relative to other UK grocers
(Lse.co.uk, 2016) which will be vital as commodity and price deflation remain prevalent.
Liquidity
The current ratio provides a key-index measure of Ocado’s short-term liquidity, whilst the acid test
provides a more robust measure by excluding inventory. Each year both Ocado’s current and quick
ratios have beaten the industry average, thanks this year to £45.8m of cash at FY15 (Ocado, 2016),
which makes us confident that the Group can meet all of its short-term obligations. While cash can
act as a drag on a company’s balance sheet, this additional liquidity, coupled by an undrawn credit
DuPont Net Profit
Margin
Asset
Turnover
Equity
Multiplier
Ocado
ROE
FY15 1.07% 187.22% 244.56% 4.88%
FY14 0.77% 176.31% 246.65% 3.35%
FY13 -1.58% 159.02% 246.10% -6.18%
FY12 -0.35% 151.37% 217.94% -1.17%
Table 5 – Du Pont Analysis
0
50
100
150
200
FY12 FY13 FY14 FY15
Graph 2 – Ocado Asset Turnover

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facility of £210m in place until FY19 (Ocado, 2016), is fundamental to Ocado’s overall strategy, as it
enables them to channel significant funding into Smart Platform growth (Seekingalpha.com, 2016).
Table 6 – Current ratios Table 7 – Quick (acid test) ratios
Debt
Table 8 shows Ocado’s coverage ratio from FY12 to FY15. Since delivering its first profit at FY14,
Ocado’s coverage ratio has improved significantly and is now sufficiently within its bank covenants,
which have also been loosened (Ocado, 2016) as a result of improved profitability. Table 9 displays
leverage ratios for Ocado and its industry peers’ average, respectively, defined as total liabilities over
shareholders equity. Since the increase in leverage at FY12 due to the Morrison’s arrangement and
the simultaneous development of its second distribution centre (Ocado, 2016), the Group’s leverage
ratio has remained relatively unchanged and is significantly below the industry average. While this
capital structure stability has been necessary as Ocado has searched for profitability, the Group now
has the potential to pursue a more aggressive debt policy over the forthcoming years, so that it can
utilise the benefits of debt finance particularly when internationalising its operations.
Quick
ratio
Ocado Industry peers
FY15 54.64% 38.45%
FY14 71.37% 50.67%
FY13 98.18% 50.05%
FY12 104.42% 45.47%
Current
ratio
Ocado Industry Peers
FY15 69.64% 54.21%
FY14 87.50% 56.37%
FY13 112.96% 63.47%
FY12 117.43% 64.20%
Leverage
Ratio
Ocado
Group
Industry
peers
FY15 1.45 2.32
FY14 1.47 1.66
FY13 1.46 1.19
FY12 1.18 1.12
Interest
Coverage
Ocado
Group
FY15 2.23
FY14 1.76
FY13 -0.23
FY12 0.85
Table 9 – Leverage Ratios
0
0.5
1
1.5
2
2.5
FY12 FY13 FY14 FY15
Ocado
Group
Industry
peers
Table 8 – Coverage Ratios

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Altman’s Z-score (Altman, 2000)
Altman’s Z-Score is a statistical tool that incorporates debt, liquidity and profitability measures into a
composite score to indicate the likelihood of the company facing financial distress. This is defined as:
𝑍 = 1.2𝑋1 + 1.4𝑋2 + 3.3𝑋3 + 0.6𝑋4 + 1.0𝑋5
Table 10 shows that Ocado is comfortably within the safe zone of > 2.99, with Z-scores of around 6
at FY13, FY14, and FY15, thus indicating that the Group is easily safe from bankruptcy.
Coeff. 1.2000 1.4000 3.3000 0.6000 1.0000
Variable X1 X2 X3 X4 X5 Z
FY15 -0.1006 0.2341 0.0365 6.2903 1.8722 5.9740
FY14 -0.0390 0.2209 0.0310 6.9261 1.9050 6.4256
FY13 0.0414 0.2152 -0.0046 8.2748 1.5902 6.8908
FY12 0.0457 0.2596 0.0076 1.6851 1.5137 2.9682
Table 10 – Altman’s Z-Score
0
2
4
6
8
FY12 FY13 FY14 FY15
Graph 4 – Z-Score history

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04
Forecasting

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Background – macroeconomic
The UK’s economic outlook remains mixed, with growth forecasts of 2.0%, 2.2% and 2.3% for 2016,
2017 and 2018, respectively (BBC, 2016). The government is pursuing austerity to meet a surplus at
FY20, which will see annual disposable income falling by, on average, £1,500 by 2020 (Women’s
Budget Group, 2016). A period of deflationary pressure is likely to persist, with interest rates on hold
and inflation expectations revised down (This Is Money, 2016) which will boost consumers’ real
incomes (EY, 2015). UK corporation tax cuts to 19% (2017) and 18% (2020) are expected (Gov.uk,
2015). While there is uncertainty over the UK’s EU position, we ultimately believe the UK will remain
inside, and thus do not consider any import duty increases or implications for globalising operations.
Assumptions
 Sales: Ocado’s turnover has risen, on average, 16.54% per year since FY10, fluctuating from
13.42% to 19.80%, indicating an upward trend that outstrips market growth. IGD (2015) forecast
the UK’s online grocery sales to increase by 92.9% to FY20. Ocado’s management, as of 2016 Q1,
expects sales to continue to grow ahead of the market (Ocado, 2016) with the implementation
of new distribution centres and the expectation of internationalising operations. Despite this, a
lack of progress has been made in securing international partners (Thomas and Brown, 2016), so
we do not expect any deal made prior to the UK’s EU referendum. Assuming the UK retains its
association, we expect to see multiple deals overseas from 2017 onwards. Austerity measures
will lead to a further shift towards Aldi and Lidl, with Kantar Worldpanel (Don, 2016) predicting
them to own 14% of the market at FY20. Despite this, Ocado’s increasing margins and market
share from FY13 to FY15 indicate that Ocado has been relatively unaffected by their presence.
Real consumer incomes will also increase, which suggests that Ocado will continue to be
protected from discounters’ lower prices. The introduction of Amazon Fresh in 2016, however,
will bring competition and reduced sales, although this is likely to be realised from FY17 once
fully operational. With online sales expected to increase by 18.58% per year from FY15 to FY20
(IGD, 2015), we see Ocado’s sales continuing to beat this. International expansion post-FY16 will
increase sales overseas, but the impact of Amazon post-FY16 in the UK, and maybe overseas, will
counteract any further sales increase. We thus assume a 19.12% YoY increase.
 Cost of Sales: Cost of sales has increased with turnover but at a slower rate, averaging 15.66%,
with no more than a 1.5% variation change between them (Ocado, 2016). As sales rise, we thus
expect cost of sales to rise at a similar level, but an extensive 2,000-supplier network increases

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procurement prospects and expansion provides scale economy opportunities. The 1-year trend
for all agricultural commodities is negative, with cattle and sugar in double-figures (FT, 2016),
which would lead to lower wholesale prices, although the sugar tax post-2018 will mean rises for
some products. We thus forecast a 17.2% YoY rise, around the 1.5% variation seen previously.
 Distribution Costs: The operational efficiency of Hatfield and Durdon CFCs has improved by
more than 10 units per hour (UPH), and we expect this to increase as the new asset fulfilment
solution is implemented - making further efficiencies in picking deliveries - and CFC 3 and 4
becoming operational. We also expect fuel-efficiency improvements, in line with Ocado’s carbon
reduction strategy, particularly with trials of electric vans in London (Van Fleet World, 2015).
We forecast a distribution cost rise of 23.5% at FY16, then a diminishing rise by 0.1% until FY20.
 Administrative Expenses: Admin expenses have continued to rise, predominately due to Smart
Platform investment, and were up 12.4% last year. Further domestic and international expansion
will incur even further fees, as would making new CFCs operational, and so we expect short-term
increases to FY18 of 14%. However, from FY18 we expect admin fee increases at a lower level of
13%, once the Smart Platform is finalised, CFCs operationalised and scale economies realised.
 Corporation Tax: We assume a corporate tax decrease to 19% from FY17 and then 18% at FY20.

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Table 11 – Forecast Ocado Consolidated Income Statement FY14 – FY20
Analysis
We forecast a 2.27% NPM at FY20 – a trend towards the industry mean norm. With Ocado’s business
model being fundamentally variable cost based as well as a natural beneficiary of the proliferation of
the online sector, efficiencies will be realised and sales will accelerate, so such a net profit increase is
justifiable. The 5-year EPS forecast - assuming no equity issuance - is shown.
Income Statement FY14 FY15 FY16E FY17E FY18E FY19E FY20E
£m Actual Actual Project Project Project Project Project
Revenue 948.90 1,107.60 1,319.37 1,571.64 1,872.13 2,230.09 2,656.48
Cost of Sales (636.00) (732.50) (858.49) (1,006.15) (1,179.21) (1,382.03) (1,619.74)
Gross Profit 312.90 375.10 460.88 565.49 692.93 848.05 1,036.74
Gross Profit Margin 32.98% 33.87% 34.93% 35.98% 37.01% 38.03% 39.03%
Other Income 39.40 49.00 58.80 70.56 84.67 101.61 121.93
Distribution Costs (253.10) (309.40) (382.11) (471.52) (581.39) (716.27) (881.73)
Admin Expenses (85.00) (95.60) (108.98) (124.24) (141.64) (160.05) (180.85)
Oper Profit bf. JV 14.20 19.10 28.59 40.28 54.58 73.34 96.08
Share results fr. JV 2.40 2.30 2.20 2.20 2.10 2.10 2.00
Exception Items (0.30) - (0.30) (0.40) (0.50) (0.60) (0.70)
Operating Profit 16.30 21.40 30.49 42.08 56.18 74.84 97.38
Finance Income 0.40 0.20 0.20 0.20 0.20 0.20 0.20
Finance Costs (9.50) (9.70) (11.60) (14.00) (16.80) (20.10) (24.10)
Profit before tax 7.20 11.90 19.09 28.28 39.58 54.94 73.48
Taxation 0.10 (0.10) (3.82) (5.66) (7.52) (10.44) (13.23)
Net Profit 7.30 11.80 15.27 22.63 32.06 44.50 60.26
Net Profit Margin 0.77% 1.07% 1.16% 1.44% 1.71% 2.00% 2.27%
EPS Monitor FY15 FY16E FY17E FY18E FY19E FY20E
Earnings (£m) 11.80 15.27 22.63 32.06 44.50 60.26
Shares (m) 590 590 590 590 590 590
EPS (£) 0.02 0.03 0.04 0.05 0.08 0.10
0.00
0.05
0.10
0.15
Table 12 – EPS forecast
Graph 5 – EPS forecast

18
05
Valuation

19
Cost of Capital – CAPM
We employ the CAPM (Sharpe, 1964) to compute the cost of equity. We utilise the UK Gilt rate as a
proxy for the risk-free rate, and adopt a 5-year horizon to minimalize exposure to reinvestment and
interest rate risk (Damodaran, n.d.). Dimson et al. (n.d.) document a real equity geometric return.
CAPM Source
5-year Gilt Rate 0.0081 Bloomberg.com (2016)
Market Return 0.0530 Dimson et al. (n.d.)
Ocado Beta 1.7500 Marketsft.com (2016)
Cost of Equity 0.0867
Fundamental Valuation – Residual Income
A residual income valuation method is most suitable, with the Group having no intention of paying
dividends (Russell, 2015) and only just producing positive cash flow (Pinto, 2010). The economic
outlook is also uncertain, so using book value at FY15 provides a benchmark for making future
estimates more reliable. The clean surplus assumption also requires no equity issuance, which we
envisage being the case with Ocado, as they look to utilise the benefits of debt whilst
internationalising. Whilst the model is reliant on accounting data which can be manipulated, our
accounting analysis reveals the Group’s accounting profile is aligned with fundamental performance.
Valuation FY15 FY16E FY17E FY18E FY19E FY20E FY21E
£m Actual Actual Project Project Project Project Project
Book Value 241.90 257.17 279.80 311.85 356.36 416.61 498.62
Net Earnings 11.80 15.27 22.63 32.06 44.50 60.26 82.00
Equity Charge 20.97 22.29 24.25 27.03 30.89 36.11
Residual Income (5.69) 0.34 7.80 17.47 29.37 45.89
Discount Factor 1.09 1.18 1.28 1.39 1.52
PV of Residual Income (5.24) 0.28 6.08 12.53 19.38
SUM PV of Residual Income 33.04
Book Value 241.90
PV Terminal Value 1,816.22
Price 2,091.16
Shares Outstanding (m) 590.04
Table 13 – Cost of Capital
Table 14 – Residual Income

20
Our 7% perpetual growth assumption in estimating terminal value RI is justifiable, reflecting Ocado’s
100% plough-back ratio, significant sales expansion forecasts, and current low market penetration
which permits considerable growth and partner opportunities. Calculations for the model are in the
appendix. We calculate the share price at 354p, 9p more than the FT’s price (Marketsft.com, 2016).
Relative Valuation – Multiples
Table 16 displays multiples, including P/E, EV/Revenues and EV /EBITDA ratios. Unlike other grocers,
Ocado is a new company with a unique business model that is aligned with the structural
transformation of the market and a competitive advantage focused on technology (Ocado, 2016).
Investors are thus willing to pay a premium, particularly with global growth prospects for the Smart
Platform (IG, 2016) and the possibility of a takeover bid from Amazon materialising (Martin, 2016).
While the results imply Ocado’s equity is overvalued, we do not believe this is representative.
Multiples Equity Multiples Firm Value Multiples
Company Name
Price/Earnings Per
Share (EPS)
Enterprise
Value/Revenues
Enterprise
Value/EBITDA
Sainsbury's 13.04x 0.56x 7.35x
Morrison’s 20.55x 0.36x 7.20x
Marks & Spencer 17.08x 0.84x 6.56x
Tesco's (excluded as minus) 0.46x 9.65x
Peer Group Mean 16.89x 0.56x 7.69x
Earnings FY15 (£m) 11.80
Revenue FY15 (£m) 1,107.60
EBITDA FY15 (£m) 81.50
Valuation (£m) 199.30 620.26 626.74
Net Debt (£m) - 127.00 127.00
Equity Value (£m) 199.30 493.26 499.74
Shares Outstanding (m) 590.04 590.04 590.04
Share Value (£) 0.34 0.84 0.85
Valuation
£
Forecasted Share Price 3.54
Share Price (Marketsft.com, 2016) 3.45
Difference 0.09
Table 15 – Share Price
Table 16 – Multiples

21
Conclusion – strong business model, growth expected
Over the next five years, we would expect to see continued domestic growth and the beginning of
international expansion for Ocado, who are able to capitalise on the efficiency of their supply-chain
and logistics systems, as well as the commercialisation of their proprietary technology and IP. Our
fundamental valuation is 9p above their current share price, and as such we would state that Ocado
is currently undervalued on the market. With the expectation of continued expansion and sales
growth, coupled with their undervalued share price, we would recommend you BUY Ocado.
(3958)
BUY

22
Appendix - Fundamental Valuation Model Calculations
PV of Terminal Value is calculated as FY21 Residual Income, £45.89m, divided by the cost of equity
minus the perpetual growth rate 7%. This is then discounted by (1 + r)^5. Formula is shown:
𝑷𝑽 𝒐𝒇 𝑻𝒆𝒓𝒎𝒊𝒏𝒂𝒍 𝑽𝒂𝒍𝒖𝒆 =
𝑹𝑰 𝑭𝒀𝟐𝟏
(𝒓−𝒈)⁄
(𝟏+𝒓) 𝟓

23
Appendix - Multiples Calculations

24
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