Tesco price cut offensive seen hurting Ocado most

22nd Sep 2011 10:21

Supermarket giant Tesco has summoned all of its store managers into work this Sunday to get ready for a price-cutting offensive. News of the initiative sent shares in supermarkets - and even more notably, Ocado, the company that delivers groceries from the upmarket supermarket Waitrose - lower yesterday.Reports say that the initiative will focus on lower individual prices instead of two-for-one offers, but will also seek to use the Clubcard to stop shoppers going to rival supermarkets.Panmure Gordon, in a research note released on Wednesday, suggested that Tesco's price offensive is very bad news for online grocery firm Ocado. "Ocado is playing with the big boys now," Panmure Gordon analyst Philip Duggan said. "Unfortunately, scale is a big advantage in food retailing, so we expect Tesco's planned price initiative to hurt Ocado disproportionately. We therefore now expect Ocado to lose money for at least the next two years. We therefore reiterate our Sell recommendation and 50p price target," Duggan said.Duggan said that Ocado price-matched Tesco on 7,400 products in the first half of 2011, so Tesco's expected change in tack to focus on "every day low prices" (EDLP) would "hurt Ocado hard".As for the likely effect on Tesco's fortunes of the price offensive, Duggan notes that "this is generally not the signal for sector price outperformance."In Duggan's view, the price offensive has to be seen in the context of an absolute commitment on Tesco's part to drive return on capital employed (ROCE) from 12.9% to 14.6% by fiscal 2015. "It therefore implies three things. First, that the investment will be proportionate and not signal a price war. Second, while there may be some investment from rising UK returns, the cost benefit equation will be in Tesco's favour on a medium term view. Finally, some of the other drivers for rising group returns are coming through strongly. Japan's losses will be eliminated and we expect that US losses will be reversed quickly," the broker said.Panmure Gordon reiterated its "buy" recommendation for the clear market leader, and its target price of 500p. Duggan thinks that Tesco moving "on to the front foot in the UK for the first time in 10 years will be good news for the shares in the long run."In a note published on Thursday, Credit Suisse says of UK supermarkets: "We expect the sector to remain attractive on fundamentals despite competition that is likely to be full-bloodied but rational."It prefers Tesco and Morrisons to Sainsbury's, whose target price it has reduced to 300p from 330p.