Broker tips: Ocado, Rentokil

14th Aug 2015 13:45

(ShareCast News) - Goldman Sachs said the sell-off in Ocado shares has been an unwarranted over-reaction to news that Amazon is planning to launch its Fresh food offering in the UK, as it will be worse news for bricks-and-mortar grocers. Goldman retained its 'buy' rating on Ocado and 'sell' on Sainsbury, which it said would be most affected due to its focus on the South East.Since The Times reported in mid July that Amazon Fresh is planning to launch in the UK, Ocado has underperformed the UK grocers circa 18%, with no other real news affecting the company in this time."Though there has been no official announcement by Amazon, this has been the subject of many investor questions. With this note, we highlight what we consider to be the relevant points behind our view that Ocado's recent share price reaction is unwarranted," Goldman said."Mainly, we believe the entrance of Amazon Fresh in the UK would be positive for Ocado, but very negative for its store based competitors."Logicor has since reported that Amazon has signed a 10-year lease on a former Tesco warehouse in Surrey, which trade publication Retail Week said was "the clearest indication yet" that Britain will see the first expansion of Amazon Fresh, which currently serves Seattle, Los Angeles, San Francisco, San Diego and New York City.But Goldman Sachs' research revealed that Amazon "does not tend to dominate" when it enters established online food retail market, such as the UK's, with Ocado in particular already having in place "the most capital efficient, low-cost food retail model in the UK"."If Amazon Fresh were to launch and significantly disrupt the UK grocery market it would accelerate growth of the online channel, and exacerbate problems for store-based competitors."A London-focused launch for Amazon's food offering would be most disruptive to South-East focused Sainsbury's, in the GS view, with 9% of its UK supermarkets and 26% of its convenience stores located in London versus 3% and 11% for Tesco.In a worst-case sort of scenario, analysts extrapolated that if Amazon Fresh's entry was to precipitate a similar margin fall as seen at electronic retailer Best Buy in the US, it could take "60%-90% from the valuation of Morrisons, Sainsbury and Tesco".But for Ocado's longer term prospects, expansion by Amazon of the Fresh brand outside of the US would even be likely to be a catalyst for Ocado's Smart Platform online grocery solution, Goldman suggested, which could lead to the first big overseas deal that the company has long been chasing. "We think this will become an increasing focus for food retailers globally as Amazon expands into grocery." Bank of America Merrill Lynch raised its price target on Rentokil to 175p from 150p as it maintained its 'buy' rating on the stock."We think Rentokil could look like a very different business in 3-5 years' time," the bank said.It sees potential for the company to materially refine and improve its business model through organic growth, exiting certain operations and investing the proceeds to build out in others.It said that if executed well, this transformation strategy could create substantial value for shareholders, from both higher earnings and a higher multiple."Our analysis suggests that paring down the portfolio and reinvesting in the higher-quality pest control operations could yield between 20% and 40% upside to the current share price over time," it said.ML said Rentokil has come to the end of a long period of restructuring, catch-up investment and distractions from non-core businesses . It said the company is more externally focussed, has a clearer capital allocation strategy and learnt from Bunzl and Berendsen, both of which have created significant value despite operating in relatively mature markets.