Ocado Group is Becoming a Technology Stock

We thought that only a Fool would consider Amazon an artificial intelligence stock, but there’s no shortage of pundits stating the same. To be fair, it’s rather difficult to place Amazon in any GICS-type industry classification bucket. As the world’s second-largest retailer by sales, Amazon is not considered a pure-play online retailer either. The company is also dabbling in cloud computing, co-branded credit cards, subscription services, and much more.

Credit: Visual Capitalist

Amazon is a great example of how tech companies today are morphing into mini-conglomerates with disparate lines of business. That’s the feeling we get when looking at Ocado Group (OCDO:LN), a company that most Americans may not know of, but that will soon be helping America’s second-biggest grocery retailer compete with Amazon and Walmart.

Ocado Group is Becoming a Tech Stock

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When three former Goldman Sachs merchant bankers founded Ocado Group in 2000, they probably didn’t think it would become bigger than U.K. grocer Tesco in just twenty years’ time, at least by market cap. With no storefronts, Ocado operates solely from large warehouses where lightning-fast robots fulfill orders made by people online. Once the orders have been picked, they’re ferried to vans for last-mile delivery. The warehouses are an incredible feat of engineering. More than 1,000 identical robots the size of washer machines race around on “The Hive,” a stack of storage bins up to 21 bins deep, totaling hundreds of thousands of bins. The robots work together, filling over 65,000 grocery orders a week.

Credit: Harvard Business Review

It’s a giant sorting machine where pallets of groceries enter, and grocery orders exit. The software is as important as the hardware, and the entire operation has a digital twin which generates loads of data that can be used for things like predictive analytics. It’s why we can’t necessarily call them a robotics company.

The Fourth Industrial Revolution

As we said earlier, it’s becoming increasingly difficult to classify companies as belonging to a particular tech theme when they cross so many. Ocado Group is a great example of this. At the highest level, we can divide their revenues into two broad segments – Ocado Retail and the Ocado Smart Platform. It’s the later segment where the technology resides.

The Ocado Smart Platform (OSP) is described by the company as being “at the intersection of six disruptive technologies: AI, Robotics, Digital Twins, Cloud, Big Data, and IoT.” They’re building the smart factory of The Fourth Industrial Revolution which combines the power of multiple disruptive technologies to create 2 + 2 = 5 synergies. It’s as much about software as it is about hardware.

Ocado talks about how they’re using machine learning to offer more personalized shopping experiences. For example, they’re using predictive analytics to suggest items you may be running out of. They also use AI for demand forecasting to predict sales for over 58,000 different products, each of which has its own prediction engine. When their delivery vans set out full of groceries, Ocado’s route-optimization systems make 14 million routing calculations and 600,000 adjustments per second.

While software does eat the world, Ocado’s hardware is pretty cool too. They’re constantly working to improve the hardware found in the most sophisticated warehouses on this planet where robots whiz around at nearly 18 miles per hour with a clearance of just one-twentieth of an inch between them. Let’s talk a bit more about the robotics companies they recently acquired.

Doubling Down on Automation

The same day Walmart announced their foray into inventory-taking robots will be scaled back, Ocado doubled down on their automation efforts. Just yesterday, they announced the acquisition of two firms – Kindred.ai and Haddington Dynamics.

We first came across Kindred in 2017 when we wrote about 6 Canadian Robotics Startups Not Called Clearpath. Then last week, we featured them in an article on 7 AI Robotics Startups for Advanced Automation. In short, Kindred.ai is developing a robot capable of displacing four fulfillment center employees per machine, and they’ve now been acquired by Ocado for $262 million. It was one of two acquisitions to be announced, the other being robotic-arm designer and manufacturer Haddington Dynamics for $25 million.

Don’t let this Las Vegas startup’s tacky 1980s website fool you. The light industrial collaborative robot developed by Haddington Dynamics is economically priced at $11,000, but seriously advanced. The 3D-printed 7+ axis robotic arm called Dexter has an FPGA supercomputer onboard which gets 0.8 – 1.6 million points of precision directly on each of the robot’s joints. We’re not sure what that means, but the end result is capable of extremely precise movements and better-than-human-touch sensitivity.

Credit: Hackaday.io

Collectively, these three companies are now working to solve one of the world’s hardest challenges in robotics, the picking and packing of groceries. Integrating these new technologies is expected to save just over $9 million in annual labor costs per warehouse (about 50% of the entire labor costs). As Ocado continues to build their technology stack, investors have rewarded their pivot by sending shares soaring.

Ocado’s Stock Soars

Ocado debuted on the public markets in 2010 and quickly became the most shorted stock in Europe. On their way to becoming the world’s largest pure-play online grocery business, they were misunderstood as being a company that subsidized grocery delivery, a luxury for the middle-class. One Tesco executive even referred to Ocado as a charity. All that changed in 2019 when another U.K. grocer, Marks & Spencer, decided to invest nearly $1 billion for a 50% share of Ocado’s retail operation. The other half of Ocado Retail would become Ocado Group, a company that provides the technology and now sells it to other grocery stores.

Ocado Group plans to empower grocery chains across the globe with distribution technology that will allow them to compete with Amazon and Walmart for online grocery delivery. While Walmart is the largest retailer in the United States, the second largest is Kroger, a company that operates over 2,700 supermarkets in the United States (Walmart has about 4,700). Ocado has entered into an exclusive partnership with Kroger to build out 20 customer fulfillment centers (CFCs) in the United States over the next three years, each costing around $55 million to build. If you’re an investor in Instacart, a U.S. grocery delivery startup that’s taken in $2.2 billion so far, that news should make you nervous.

In total, Ocado has commitments to build out 54 CFCs internationally with other supermarkets like Coles in Australia, Aeon in Japan, Groupe Casino in France, ICA Group in Sweden, and Sobeys in Canada, as the global grocery industry does its own pandemic pivot.

Credit: Ocado

The transition from retail to technology adjusted investors’ expectations and consequently, share prices have soared. A BBC article on the matter talks about how investors are willing to ascribe just about any value to growth. Ocado has only 1.7% of the UK grocery market, compared with Tesco’s 26.8% share, yet both companies now share roughly the same market capitalization. Ocado’s revenues from the CFCs they’re building overseas are slow to trickle in while they’re burning loads of cash to build them

Today, about 30% of Ocado Group’s revenues are attributed to the fees they’re getting from their tech platform in the U.K. while international revenues begin to trickle in with both Sobeys and Casino coming online with CFCs this year.

Credit: Ocado Group Investor Deck

Ocado Retail also includes two other brands: Fetch, an online pet store, and Ocado Zoom, a new one-hour grocery service. It shows how this technology platform can go beyond grocery into other areas of retail, perhaps even dark kitchens (restaurants that only serve delivery customers). Last year, Ocado led a $9 million seed round investment for Karakuri, a robotics startup developing robotics solutions for preparing meals. Given how many other startups are working on warehouse automation, there’s plenty of technology out there for more acquisitions in the future.

Conclusion

Ocado’s an exciting company, but we’re wary about how much future growth potential is already priced into the stock. Shares are up +100% year-to-date compared to a Nasdaq return of +26% over the same time frame. Given we’re already concerned with the market seemingly ignoring the unknown impact of a pandemic that’s devastating entire industries, we’re liking Ocado, but not loving it enough to buy shares at the moment.

Pure-play disruptive tech stocks are not only hard to find, but investing in them is risky business. That's why we created “The Nanalyze Disruptive Tech Portfolio Report,” which lists 20 disruptive tech stocks we love so much we’ve invested in them ourselves. Find out which tech stocks we love, like, and avoid in this special report, now available for all Nanalyze Premium annual subscribers.

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