Morrisons and Ocado extend online grocery deal, analysts say both sides benefit

Morrison's has agreed to take 30% capacity of Ocado new customer fulfilment centre (CFC) in Erith by 2018, bought a new 'store pick' software licence and eased previous restrictions on the online specialist working with other UK supermarkets.

Ocado will providing a store pick software solution that will enable Morrisons to fulfil online orders via its stores all over Britain as soon as next year, with its current arrangement being limited to the location of existing CFCs.

The rolling back of competition restrictions, means Ocado is only prevented from working with only Tesco, Sainsbury's, Asda, Lidl and Aldi, which opens up potential for deals with the likes of Co-Op, Iceland, M&S or even Waitrose as it struggles to secure the long-trumpeted overseas contract.

For the Bradford-based supermarket the deal will push back the break-even point for its online business Morrisons.com "slightly later than originally planned".

Ocado, which as part of the deal will waive its right to a maximum 25% profit-share when Morrisons.com becomes profitable, said the new agreement would boost earnings but that this would be counterbalance by increased costs in the current and next financial years.

Morrisons will contribute 30% of the initial building costs of the Erith CFC, which has a planned peak sales capacity of £1.2bn, and a similar percentage share of all ongoing building and other fixed costs, including rent and rates and a pro rata share of all variable costs.

For the supermarket group, which is also increasing the range available from Morrisons.com to include thousands of non-food items that are currently available via Ocado, this arrangement has significantly lower upfront capital costs than the original operating agreement and includes an option to break after five years.

Credit Suisse analysts said the store pick agreement presents a capital-light, incremental avenue of growth and significantly expands the geographical reach for Morrisons.com.

"However, it is also positive for Ocado - while store-pick software fees will be lower than CFC fees, rolling out the software for store-picking beyond the initial phase is relatively costless and profitability should scale well as Morrisons online grows."

Shore Capital moved from its long-time 'sell' to a 'hold' rating on the news, saying: "Whilst Ocado has given up pre-ordained fees and margin, the group has potentially secured better long-term cash flows and created a credible basis, perhaps, to engage with the long list of international partners that [chief executive Tim] Steiner has reportedly said are patiently queueing around Hatfield awaiting Ocado’s blessing to work with them."

Numis left its forecasts unchanged, saying there is limited information on key economics within the agreement but was "encouraged by the clear endorsement of OSP by Morrisons and the longer-term earnings accretion that the agreement should provide for Ocado".