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Waitrose lawyers looking at deal details after Ocado looking at tie-up with Morrisons

Ocado has dropped 8% on concerns about the effect of its proposed tie-up with Morrisons on its existing deal with Waitrose.

As the Guardian reported on Friday, lawyers for Waitrose are poring over its deal with Ocado to see if any move by the online grocer to help Morrisons set up a website would constitute breach of contract.

The news followed a protest vote by shareholders at Ocado’s annual meeting on Friday over board pay packages, including a 30% salary rise for chief executive Tim Steiner.

Ocado’s shares – which have been up sharply in recent days in antipation of the Morrisons deal – are currently down 18.2p at 206.4p. Analyst Clive Black at Shore Capital repeated his sell recommendation, saying:

The business seems to be evolving from an aspiration to be a proprietary retailer into a landlord of its two customer fulfilment centres and licensee of its kit to third parties. Whilst a notable potential change in strategy, it could be argued that it signals an admission of defeat by Ocado; so the introduction of Plan B.

We believe that Ocado is playing with fire in speaking to another British supermarket group, as it tries to utilise its substantially greater fulfilment capacity, because the group’s umbilical cord to Waitrose may be cut sooner than we anticipated and Ocado cannot exist as a commercial entity without Waitrose in our view.

Whilst Ocado states that any agreement with Morrison’s would not be a conflict with Waitrose, we see the mood of [Waitrose chief executive Mark Price] as being deadly serious. As such, Ocado may have irreparably polluted a commercial relationship upon which it is dependent and it must lead to a greater chance of a break in 2017 in our view. Additionally, Waitrose’s understandably forthright stance means that the prospect of Morrison and Waitrose brands simultaneously utilising Ocado’s fulfilment centres and vans is low. As such, the extent of a tie-up between Morrison and Ocado needs to be pencilled down, along with it the financial extent.

The strong appreciation of Ocado’s shares makes the stock more attractive for investors to bank gains and effectively short to our minds. Aside from now uber-stratospheric valuation multiples, the stock does not offer the prospect of a dividend anytime soon either, unlike all of its UK listed food retailers. Whilst we pride ourselves on taking reasonably long-term and strategic views of companies and industries, the time horizon for Ocado to be meaningfully profitable so that it pays a dividend to its shareholders is very extended; in fact it probably remains decades away, if ever. Now, many investors commendably operate on multi-decade timescales, but again, we believe that this is not applicable in Ocado’s case because it is selling multi-temperature foodstuffs where margin expansion potential is structurally low.