Ocado’s Delayed Robotic Warehouse Rollout, High Capex, 21x Net Leverage, Cash Burn Highlight Refinancing Risk; Equity Raise or Refinancing With Converts Would Be Dilutive to Equity

U.K. online grocer and technology company Ocado’s 3.875% 2026 notes have fallen to about 85-mid from about 88-mid on June 19, after the company’s Canadian partner Sobeys said it would pause the opening of its fourth customer fulfillment center, a robotic warehouse, originally planned for 2025, while also ending its exclusive automation technology agreement with Ocado.

The news, which followed a similar announcement by Ocado’s U.S. partner Kroger last September, reflects the decline in enthusiasm for online grocery shopping that has taken place since the pandemic. That may damage Ocado’s growth prospects, which together with the company’s persistent cash burn will make it harder for the group to refinance its £1.45 billion debt maturities coming due from 2025 to 2027, investors said.

The company has £600 million of unsecured convertible notes due 2025, £500 million of senior unsecured notes due in 2026 paying 3.875%, and £350 million of unsecured convertible notes due in 2027.

Ocado has heavily invested in technology via its Technology Solutions segment on expectations of continued dominance of online shopping over in-store sales. The software and robotics segment provides the Ocado Smart Platform, or OSP, automation technology for warehouses as a managed service to partners around the world. As a result, the company racked up capital expenditure bills that reached a peak of around 31% of sales in 2022, before falling to a still substantial 19% of sales last year, in the hope that the rollout of robotic centers for its international partners would drive growth.

However, the strategy has not been as successful as the company hoped, and the group’s performance remains squeezed between the low margins faced by its legacy U.K. grocery business, which generates about 68% of revenue (excluding inter segment eliminations), and the consistently high capex and low (mostly negative until last year) EBITDA of its international technology solutions business.

Cash burn totaled about £479.3 million in 2023 and £825.8 million in 2022, according to Fundamentals by Reorg, and has been persistently negative for at least five years.

The table below shows Ocado’s annual levered free cash flows from financial years 2016-2023, according to Fundamentals by Reorg:

Net interest paid was £14.6 million in 2023 and £46.2 million in 2022. In the current higher interest rate environment, if the notes were refinanced, which will be challenging, cash interest costs would jump, with a coupon on any new notes likely to be closer to the yield of about 11.5% on the £500 million 3.875% senior unsecured notes due in 2026, further exacerbating cash burn.

As of December, the company had available liquidity of about £1.185 billion, including a £300 million undrawn RCF. However, at current cash burn levels, this could be entirely eroded within 2-3 years.

Net leverage is at 21x as of December, highlighting the unsustainability of the company’s capital structure, investors noted.

Ratings agency Fitch downgraded Ocado and its senior unsecured debt to B- from B+ in May, citing slower expected growth in profits due to the slower rollout of international CFCs and refinancing requirements in a higher interest rate environment. Ocado is rated B3 by Moody’s and is unrated by S&P.

The company’s shares are quoted at 309 pence per share, resulting in a £2.5 billion market cap. The share price fell to 310 pence per share on June 20 from 352 pence per share on June 19 as a result of the news about Sobeys pausing the rollout of its fourth CFC. At their peak, Ocado shares traded almost 10 times higher than their current level at 2,808 pence per share in early February 2021, boosted by the shift to online grocery shopping during the pandemic.

As of the end of last year, 26 CFC sites and 111 smaller related modules were live in the U.K. and internationally. This contrasts with the expectation set out in the offering memorandum for the group’s 2026 notes, which stated that Ocado’s international partners had publicly announced an intention to develop, in aggregate, the equivalent of 56 CFCs. Ocado was not clear on the timeframe for the rollout, but a chart in the OM seems to suggest it expected them to open this year.

The company says it is on track to be cash flow positive in the mid-term due to growing recurring fees from clients as live modules increase, lower direct operating costs as the business scales, technology investment having peaked, expected group support cost efficiencies and capex unit costs continuing to decline. However, this may be difficult to achieve, investors said.

The company is part way through the transition toward an asset-light mode, however, this means it still has the slim operational profitability of a grocer with the hefty capex of a tech company, which doesn’t work, investors said.

One solution would be to sell the remaining 50% stake in the Ocado Retail joint venture to its partner Marks & Spencer, one buy-sider suggested. That way Ocado could focus instead on its technology offering, where it is best in class with its automated fulfillment centers, which will drive future profitability more than scaling up of retail, the source said.

Equity Value and Dilution

Ocado has a mountain to climb to refinance its debt, but its notes are still trading in the 80s, so are not at distressed levels yet, another investor noted. That is likely down to the group’s market capitalization of about £2.5 billion as of July 4, the investor said. Although this has declined from about £2.9 billion on June 19, the day before the Sobeys announcement, and from around £23 billion at the height of the pandemic in September 2020, it is still a significant equity cushion, he said.

As long as the Sobeys and Kroger decisions to halt rolling of CFCs do not significantly dent equity growth prospects, the company should be able to refinance its outstanding convertible bonds with new convertibles (albeit at a higher coupon than the 0.875% and 0.75% current coupons on the converts) and possibly undertake an equity raise to refinance its senior unsecured note, the source said.

Ocado’s retail business should generate about £60 million EBITDA this year as a result of higher margins compared with £10 million EBITDA last year, the investor said. Ocado’s first-quarter trading update indicates that retail revenue is increasing, and the increase is primarily driven by higher volumes rather than simply increasing prices. In fact, year-over-year price increases were below inflation at 2.2% for the quarter.

And the company is targeting capex of £475 million this year, down from £536 million last year, he added. In total that’s £111 million less cash burn, he said.

Ocado also benefits from negative working capital, providing an additional source of cash as revenue grows, the source said.

The company is guiding to the adjusted underlying EBITDA margin for the retail segment increasing to about 2.5% this year from a 2023 margin of 0.42%, as calculated by Reorg, with Ocado retail revenue expected to grow at mid-to-high single-digit levels.

The equity analyst consensus is less optimistic, projecting a median adjusted EBITDA for the retail segment of £33 million this year. However, analysts expect adjusted EBITDA across the company to increase by about £63 million year-over-year to £117 million.

However, a new convertible bond issuance followed by another possible equity issuance would be very dilutive for the company’s shares, another source argued. And if anything goes wrong with the rollout of further CFCs, the company's share price could lose the majority of its value, the source added.

Ocado was contacted and declined to comment.

Ocado’s capital structure is below: