Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Ioannis Pontikis. He's an equity analyst at Morningstar in Amsterdam. Hello.
Ioannis Pontikis: Good afternoon.
Black: So, you've just published a deep dive, a report about Ocado. What is the report about?
Pontikis: We published a deep dive for Ocado Group, an online grocery market observer. I'm sure many of our viewers in the UK are familiar with Ocado Retail, which is the largest pure online grocer in the UK. However, our report is more about the solutions segment through which Ocado can fulfill and license their proprietary technology to large grocers around the globe. So, in our report, we've looked at the economics of CFCs, the customer fulfilment centers, which is the main operation of Ocado. We've looked at the potential profitability for partners, the competitive landscape. And more importantly, we looked for the global opportunity ahead for Ocado which we think is a function of the online grocery penetration rates in the developed world.
Black: But that's just it. People think of Ocado as being a supermarket business, but actually, it's got different characteristics, its logistics and software. What is it that you think is unique about it compared to its competitors?
Pontikis: Yeah, that's right. So, in our opinion, Ocado operates the most efficient online business model for grocers nowadays, which we think could provide with significant advantage to their partners relative to their peers.
Black: So, despite that, it's obviously got lots going for it, but you've given it a Morningstar No Moat rating. What does that mean?
Pontikis: Yeah. So, we think that Ocado is still at the early stages of its international expansion. This comes with significant execution risks ahead and this increases the likelihood of a permanent value destruction ahead, which renders the assignment of a narrow or a wide moat rating premature.
Black: And the shares are also trading below what you consider to be their fair value, which earns the stock a 4-star rating. What do you think the market is missing?
Pontikis: Yeah. We see a 20% – roughly 20% upside from current levels. We think the prevailing sentiment underestimates Ocado's technological capabilities versus competitors while at the same time overestimates grocers' ability to weather this poorly understood online grocery disruption that is currently underway.
Black: But that is it. The disruption is only just underway. Groceries online business is still really small, isn't it? Why is that?
Pontikis: Yeah, it's pretty small. It's low-single-digits in the developed world. In the U.K., probably it's around 4%, 5%, 6%. So, we think this is mostly a function of high delivery fees, and low poor-quality service levels, like, high substitution rates, long delivery windows, not so great freshness. So, we think these are all factors contributing to – or have contributed in the past to low, slower online adoption in grocery segment.
Black: So, do you think that will grow? What are the drivers here?
Pontikis: Yeah, we think – I mean, following the same logic, we think that more efficiencies, more investments by grocers, industry disruptors like Ocado, those investments will drive efficiencies and will decrease delivery fees considerably in the future, while at the same time will improve their service levels. So, all these we think will contribute to a virtuous cycle. At the end of the day, this will significantly increase online grocery market shares in the future.
Black: Ioannis, thank you so much for your time.
Pontikis: Thank you very much.
Black: And thanks for joining us.
