While seen as widely positive for e-commerce player Ocado, for M&S the impact is rather less clear with a £600 million rights issue announced in order to finance the deal as well as a 40% dividend cut.
Shares in income favourite M&S tanked 10% to a seven-month low on the news, while Ocado’s share price rose 5%.
The agreement will make both M&S food and general merchandise available on Ocado.com from September 2020, replacing Ocado’s long-standing deal with Waitrose. Ocado will continue to supply its own-label products and big name branded goods on the platform, too.
“I have always believed that M&S food could and should be online,” says chief executive Steve Rowe. “Combining the strength of our food offer with leading online and delivery capability is a compelling proposition to drive long-term growth.
“This is a transformational step forward in shaping the future of M&S and in becoming a truly digital-first retailer with at least a third of the business online.”
Is This a Good Deal For Marks & Spencer?
On the face of it, says Ian Forrest, research analyst at The Share Centre, it’s a good, if long overdue, move. For Laith Khalaf, senior analyst at Hargreaves Lansdown, the firm can no longer afford to ignore the online audience for food.
The economics make complete sense for M&S, too, Khalaf explains. Customers tend to shop at M&S Food for special occasions or out of convenience rather than using it for their weekly shop. As a result, their basket sizes are small, at under £30.
“This makes the economics of online delivery challenging,” says Khalaf. “By teaming up with Ocado, where basket sizes are over £100, it makes an online proposition viable.”
The market should take the rights issue in its stride, he adds, as it’s exchanging cash for a valuable asset in the form of half of Ocado’s UK grocery business. The dividend cut, on the other hand, certainly won’t be welcomed.
The company says the payout is being reset “to a sustainable level”, which it expects to be 7.1p per share in 2018/19. It will then grow in line with earnings over time. It’s a move to strengthen its balance sheet and give it “the right balance of investment and shareholder returns”, it explains.
While it’s needed to drag M&S into the 21st Century, says Khalaf, income investors don’t like cuts of that magnitude and are prone to dump a stock if it doesn’t continue to meet their need for a decent yield. “That’s likely to heap downward pressure on the share price,” he adds.
Hitherto a “hold at best for investors seeking a balanced return and willing to accept a medium level of risk”, Forrest says The Share Centre has placed its recommendation on M&S under review. Many fund managers and retail investors will be doing the same, no doubt.
Good News Keeps Coming for Ocado
The deal is good news for Ocado and continues its run of contract wins, which kicked off with May’s transformational Kroger deal. The US grocery giant paid $122 million for exclusive use of Ocado’s technology in the States. Shares in the UK’s e-commerce platform doubled in the following couple of months.
Shares climbed 5% to 1,034p on Wednesday, just shy of the all-time high hit in July and have now recovered from a fire at its Andover distribution facility that sent the share price down 15% earlier this month.
Both Khalaf and Forrest note that the M&S deal will give Ocado fresh funds to invest in its distribution centres to help fulfil those international partnerships it has recently signed. It will also replace Ocado’s long-standing and rather acrimonious agreement with Waitrose, which ends in 2020, notes Khalaf.
One fund manager who bought into Ocado at the higher valuation was Rathbones’ James Thomson. He added the stock to his Morningstar Silver Rated Rathbone Global Opportunities fund in August and is unfazed by having missed out on 100% of share price gains.
“Fund managers spend a lot of time lamenting. ‘‘I wish I’d seen that earlier’, ‘it’s too late now – I missed it’,” he told Morningstar.co.uk last week. “You’ll often be surprised how long great companies continue to be great.”
Thomson says the Kroger shows Ocado “is truly something special”, dubbing it “the best technology company in the UK”. Admittedly, there’s not much competition, but it’s high praise for a manager who owns the likes of Amazon, Tencent and Paypal.
He adds: “If the largest supermarket retailer in the United States comes over and picks Ocado’s technology, what greater verification of its prowess than that? Even if we’ve missed a huge amount of the initial growth in the company, I think they’ve got all of the ingredients to continue that success.”
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