Battered by price wars and the rise of foreign discount stores, the grocery industrys light at theend of the tunnel has been the growth online shopping, but will the entry of Amazon Fresh into the market have signicant repercussions for market leaders such as Tesco (LSE: TSCO) andOcado (LSE: OCDO)?
Amazon Fresh, the online retailers grocery delivery service, has rolled out a soft launch inBirmingham and London to select Prime members, but has yet to publicly announce further specics on the cost of the service. However, one thing we do know is that Amazons notorietyfor ignoring protability in favour of building up market share means that the already low online margins that grocery chains enjoy are going to be pushed even lower.
Nearly 6% of all grocery sale are now made online in the UK, and a recent IGD research notepredicts online ordering will account for 8.6% of overall sales by 2020 with a value of 17 billion. Meanwhile, the legacy chains are expected to shutter stores as discount competitors such asAldi and Lidl expand and continue taking physical market share. This means that despite the low protability, online sales represent a lifeline for the large chains to increase sales.With all the doom and gloom surrounding Tescos recent losses and 22bn mountain of debt, one of the few bright spots for management to point out has been their nearly 50% share of online sales. However, customers resistance to paying for the full cost of delivery means thatTesco is aiming for far lower than the traditional 5.2% margins they targeted on in-store sales.Tescos low delivery charges mean that they will likely hold a solid lead over Amazon Fresh, whichin the United States charges both a yearly subscription fee and a high delivery fee, and will also be able to serve a much higher number of customers due to their vast network of stores.For these reasons, I believe Amazon Fresh will do little to affect the bottom line of Tesco; however,the company still faces signicant headwinds from other sources and will remain toxicfor investors for some time.
The company with the most to fear from Amazon Fresh is the online-only Ocado,which already operates with margins under 1%. Ocado has followed the Amazon model of pouring cash back into building out distribution networks, and has successfully built up a 10%market share and nally turned a small prot of 7 million last scal year.However, if Amazon decides to aim for market share at all costs such as initially running the business at a loss, as it has done with other divisions in the past Ocado shares will continue to be hit hard, as the growth baked into current valuations appears to be misplaced. Despite thestock being down 30% from highs in July, the company is still trading at an eye-watering 299 P/E ratio.
I see Amazon Fresh as a major issue for Ocado, as both companies will be ghting over thesame high-spend customer and Ocado is incredibly limited in itsability to lower prices in response to any loss-making prices that Amazon can survive. For this, and the companys loftyvaluations, I would stay away from the stock until management can prove their ability to continue growing market share.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
