Morrisons’ Ocado deal leads Waitrose to focus on legal action

19-May-2013 - Last updated on 20-May-2013 at 17:26 GMT

Morrisons' deal with Ocado could prove 'a potential waste of capital' for the supermarket, warned Shore Capital

Waitrose is considering legal action after its long-term online grocery distribution partner Ocado signed a deal with Morrisons last week.

A Waitrose spokeswoman said: “We have instructed lawyers so that we can get a clear and unequivocal view of the contract and examine what might constitute a breach. This process will take some time …”

News of the deal prompted City analyst Shore Capital to downgrade its financial expectations for Morrisons but lift them for Ocado. While the deal was a good move for Ocado, it could prove a waste of money for Morrisons, said Shore Capital analysts Clive Black and Darren Shirley.

Ocado’s management had negotiated exceptionally well and without the Morrisons’ tie-up, the online grocery business was “doomed”, they said.

But they worried the deal would mean Ocado would forfeit its partnership with Waitrose within four years as the group transforms from “a proprietary grocer to a logistics and web advisory provider of sorts”.

‘A potential waste of capital’

The risk for Morrisons was “a potential waste of capital that does not yet credibly lead to a profitable grocery online business”. While Ocado can have industry leading efficiencies, the capital investment to achieve them and the still high distribution costs make this model flawed, said Black and Shirley.

“Following this deal, Morrisons’ profits are therefore, again, downgraded and we believe it has all to do to show that it can cost-effectively distribute to a fragmented customer base from a centralised facility,” they said.

Ocado – with a gross margin that was much bigger than Morrisons’ – could not make a profit after 11 years servicing the fastest growing store-based retailer (Waitrose) in Britain, they noted.

Shore Capital offered a ‘sell’ recommendation on both Morrisons’ and Ocado’s stock.

A second ‘dark store’

Meanwhile, Waitrose said sales at Waitrose.com were up by 50.1% in the first quarter of the year. The retailer also planned to open a second ‘dark store’ – or dotcom only shop – in London next spring.

Richard Wallace, online retail analyst with grocery think-tank IGD, said that while online grocery shopping was a relatively small part of the market, together with convenience, it was one of the fastest growing areas.

“At IGD we see the online channel as relatively immature, with retailers around the world trying out many different models,” said Wallace. “Retailers will seek to meet shoppers’ changing needs with what we call ‘multi-channel, multi-format’ solutions. Online grocery shopping will be an increasingly important part of building loyalty.”

International investment bank Altium agreed that the Morrisons/Ocado deal was “excellent” for Ocado. Sam Fuller, Altium’s UK head of consumer and leisure, said: "On paper the Morrisons deal looks like an excellent one for Ocado and a ringing endorsement of its platform and business model.

“Morrisons is one of the big four supermarket chains but its lack of online service and local convenience stores has put it at a disadvantage to its rivals.”

The 25-year deal will offer Morrisons much more visibility in the marketplace and provided Ocado with the security it needs by generating funds for the firm to pay down debt, he said. “Morrisons, which is strong in the north of England, also offers Ocado a counterbalance to its deal with Waitrose, which is much stronger in the south.”

But Waitrose could take legal action to try to prevent the Ocado-Morrisons partnership going ahead before Ocado’s contract with Waitrose expires in 2017, he warned.

UK online grocery market