Skip navigation Scroll to top
Scroll to top

The unsung 'tech' hero

03 July 2020

shutterstock_1200.jpg

James Follows, Head of UK Equity 

Enthusiasm for online grocery retailing has been rising steadily in recent years, but COVID-19 has accelerated adoption, and retailers across the world have been reassessing their store-based strategy. Tesco's recent first quarter trading statement revealed strong like-for-like sales growth of 8.7% in Great Britain and Northern Ireland. Online sales were particularly strong during the quarter and moved to 16% of the UK total (from 9% previously). Online growth in grocery retail has been constrained historically by the poor economics of the current model (order 'picking' in stores), but the introduction of Central Fulfilment Centres (CFCs) from one British company have been adopted with enthusiasm by the likes of Kroger in the US, Coles in Australia, and Aeon in Japan. 

That company is Ocado. 

You may think of it as just being the name behind the delivery vans that now are a fairly familiar sight on the streets of Britain, but the bulk of its valuation is linked to the technology that it sells to retailers around the world. And reflecting that, it is actually classified as a 'Tech' stock and not a retailer by the London Stock Exchange.

Its CFCs are highly automated warehouses, and they are being ordered in bulk by the likes of Kroger because they change the economics of the equation. They actively help to remove a layer of cost (i.e. physical stores) and thanks to the sophistication of the technology, a 50 item grocery order can be compiled in roughly 15 minutes. A CFC takes approximately two years to construct and it should carry 50,000 or so different items. The capital expenditure incurred by Ocado is roughly £50m for each CFC and this relates to the automation and mechanical handling equipment that it installs. The cost of the facility construction is borne by the customer. Ocado gets an initial licence fee on sales, but more importantly, it also gets annual fees linked to the sales that the CFC processes. This is a very modern twist on an old-style 'razor and blades' business model, where world-leading intellectual property is the key to the generation of very sticky long-term cash flows.

Within the firm’s original CFC – a giant automated warehouse in Hatfield – the automation was essentially a series of crates whizzing along a 25km-long network of conveyors over 5 floors. In the latest version of a CFC, however, one sees a system of stacked containers arranged in a grid frame structure, known as the ‘hive’. Products are stored in bins within the hive that are automatically moved to the top level of the structure when required. Teams of robotic load handling devices (or 'bots') are linked wirelessly to the system via a 4G connection. They move across the top of the hive, collecting products, ferrying them to pick stations where the customer order is put together, and then transporting the filled customer boxes (or 'totes' as Ocado calls them) to the goods out area for loading into trucks. This is what the inside of the CFC looks like and according to Ocado.

hug-machine.jpg

In practical terms, a CFC is just like a huge machine, with groceries going in one end and shopping orders coming out the other. Humans do the unpacking and packing, while in the middle, robots sort and rearrange this vast inventory 24 hours a day. A central algorithmic system directs the 'bots' around the hive and in essence they handle all tasks – stock storage, movement of customer totes to pick stations. All of the bots are interchangeable. The software plans the picking sequence for each shift. It also ensures the right products are in the right places, and it calculates the most efficient route for each crate. All the operational and sensor data from the bots are streamed to the cloud where a machine learning based healthcare system performs powerful predictive analytics and drives preventative maintenance. A first-in-first-out stock operation assists in minimising wastage, while also enabling use-by dates for products to be printed on the customer invoice.

As the CFCs are modular, they can be scaled up with relative ease, but they are not a cure-all panacea as their relative size (and a commensurate need for good throughput of orders) means that they are best suited for urban areas with a high population density. Recognising this limitation, Ocado has also developed a 'Zoom' micro-fulfilment centre (MFC), which can be used in more sparsely populated regions, or as an 'infill' option in urban areas to service the needs of 'convenience' shoppers. An MFC costs c. £10m and it can be constructed in 8-10 weeks. These smaller centres will carry 10,000 or so different items and will have order fulfilment speed akin to those of a CFC. We believe that it will be a successful format and in our view, potential MFC orders will be an integral part of Ocado's growth from this point on. As all of the group's automated warehouses (i.e. larger CFCs and smaller MFCs) are also platform agnostic, and suitable for non-food items as well as food items, we suspect that Ocado will end up receiving orders from a variety of global corporations.

Return to Insights

This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Vestra LLP gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Vestra LLP, employees and associated companies for any direct or consequential loss arising from this document.

LGT Vestra LLP is authorised and regulated by the Financial Conduct Authority (FCA).