Does the launch of AmazonFresh spell the end for Ocado Group plc?

Will Amazon Fresh undermine Ocado Group plc’s (LON: OCDO) business model?

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After years of speculation, internet giant Amazon finally launched its food delivery business this week.

The service, named AmazonFresh is now available to customers in 69 Central and East London postcodes who are members of the online retail giant’s Prime subscription service, for an additional £6.99 a month. The service promises fresh food at every day low prices.

And if successful, the initial trial will be rolled out to other major cities around the UK in the near future.

Bad news for some

The news that Amazon has finally launched its food delivery service is a disaster for struggling online retailer Ocado (LSE: OCDO). Indeed, Ocado’s entire business model is built on the basis that the firm’s proprietary factory technology and machinery, which enables the group to run with minimal staff, would help it out-manoeuvre larger peers such as Tesco, Sainsbury’s and Morrisons.

Amazon is well known for its use of technology to lower staffing costs, and the group’s global dominance means that it can achieve economies of scale that smaller competitors like Ocado just can’t match. Simply put, Ocado has lost its edge, and now AmazonFresh has entered the UK’s cut-throat retail market, life is likely to become a lot harder for the smaller retailer.

AmazonFresh now offers customers a range of more than 130,000 grocery items, including fresh fruit, vegetables, meat, and fish, which means that consumers can now use the service to do their entire weekly grocery shop. What’s more, one of Amazon’s main suppliers for fresh produce is Morrisons, despite the fact that the retailer already has its own website operating in partnership with Ocado. 

It looks as if Morrisons has hedged its bets quite well here. While Ocado stands to lose out significantly from the launch of AmazonFresh, Morrisons is likely to come off unscathed as increased business from its partnership with Amazon is likely to offset sales declines anywhere else.

Struggling retailer

Ocado has struggled to report a consistent profit since its IPO in 2010.The launch of Amazon’s new grocery delivery service will only make it harder for the firm to meet its lofty growth targets going forward. City analysts currently expect the group to report a pre-tax profit of £14.6m for 2016, which translates into earnings per share of 2.4p and a P/E ratio of 108 with the shares at 254p.

As AmazonFresh has only just started its rollout across the capital, City analysts have yet to factor-in the effect the new grocery service will have on Ocado’s earnings. However, Amazon is promising customers rock bottom prices and the Amazon group seems to have an unlimited amount of capital to throw at marketing and investment. So it isn’t overly pessimistic to assume that Ocado will struggle to compete with this new delivery service.

Unfortunately for investors, with Ocado’s shares currently priced for perfection at that 108 times forward earnings figure, if the group fails to meet the City’s lofty growth forecasts, its premium valuation could disappear very quickly.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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