The Morrisons-Ocado deal: What the analysts say

We view the news as a positive endorsement of Ocado’s technology and business model as well as a positive financial impact. The company guide that in its first full year the deal will contribute mid-single digit growth to revenue and add a mid-teen million pound improvement to net profit, the EBITDA impact is likely to be £4-5m higher. While 50% of CFC2 (Customer Fulfilment Centre) capacity will now be available to Morrisons, the deal still leaves sufficient headroom for Ocado to grow retail revenues materially over the next three years. The releases states that Ocado expects to commence a site search for a third logistics centre (CFC3) at the end of FY14E. The announcement has positive implications for the company’s potential earnings over the next three years, as well as significantly improving the balance sheet position of the business - Franklin Walding, Goldman Sachs

We find it hard to believeve that the Ocado/Waitrose agreement allows the same real estate, machinery and personnel to distribute another food retailers’ wares. Whilst Ocado will of course argue that the two halves of the distribution centre will be discrete, the difficulties of separating branded products, and sorting out ‘best execution’ between Waitrose and Morrisons will be highly complex. There is a break clause in the Ocado/Waitrose contract in 2017, but either side can walk away from the deal early (with a penalty of £40m, we understand). We think that the chances of an early end to the contract has increased materially with today’s developments. Our view is that Waitrose would have ended the contract in 2017 anyway, as it moved all the sales of its product that currently goes through Ocado onto the waitrose.com platform - Jonathan Pritchard, Oriel Securities

It is interesting that Morrison’s move online, whilst necessary to accommodate changing consumer preferences, is going to negatively impact EBIT for at least five years. The transaction will also drive Morrison’s net debt/EBITDA > 2x [greater than two times] for the first time since the acquisition of Safeway in FY06 which, if there was any doubt, will likely curtail any further cash return in the medium-term. With pressure on operating margins stemming from a moribund consumer environment, persistent inflation driving negative real wage growth and still high level of promotion in the industry, we see this move as further pressure on Morrison’s EBIT margin and we remain Sellers - Caroline Gulliver, Espirito Santo

Morrison’s announced £216m investment in Ocado’s new Dordon automated pick centre is, we believe in our view, a misguided venture in terms of their late entry into the highly developed and competitive UK on-line grocery market - Mike Dennis, Cantor

The massive jump in the Ocado share price first thing this morning reflects the fact that they have struck an extraordinarily attractive deal with Morrison’s, transforming their balance sheet and P&L. Waitrose will grumble about it, but if the Morrison’s money enables Ocado to continue to improve their IT systems and service then their supply contract should continue after 2017 - Nick Bubb, independent analyst

We are left wondering, what Waitrose will think of the deal? It appears that Ocado is not in breach of its contract with Waitrose, so we don’t expect anything to happen in the short run. However, the chances of Waitrose exiting from its supply arrangement in 2017 must now be high. If this were to happen, there would be a big hole in Ocado’s business and while there is time to build up the necessary infrastructure, it will lose Waitrose’s buying power as well as all of those lovely own label products. The deal will be a big help to Ocado’s profitability from its first year. Ocado expects that its net profits will benefit by mid-teen millions. EBITDA will benefit by £4-5m more than net profit, mostly due to higher interest charges, driven by an increase in finance leases. We have therefore increased our forecasts commensurately. There is also the implication for the valuation, as Ocado becomes a logistics and warehouse operator. These are severe, especially as we doubt that there will be a queue of global food retailers seeking to pay Ocado to build warehouses and help them to set up online - Philip Dorgan, Ocado

The terms of the 25-year agreement will offer Morrisons much more visibility in the marketplace and provides Ocado with the security it needs by generating a welcome chunk of funds for the firm to pay down debt. 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. That said, Waitrose has made some ominous noises about a potential tie-up with Morrisons and its reaction to it. At best it is likely to annoy Waitrose. At worst it could result in legal action to try to prevent the Ocado-Morrisons tie-up happening before Ocado’s contract with Waitrose comes to an end in 2017 - Sam Fuller, Altium  

This is a major strategic development for Morrisons. The tie-up with Ocado will allow it to springboard its way up the online food chain as the deal gives the grocer a ready-made platform for a successful online business. The next few months will be key in developing an effective marketing strategy, but things are certainly looking bright for Morrisons - Dan Coen, Zolfo Cooper