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Will, Inc. Eat Tesco PLC?

The grocery sector is dog-eat-dog at the best of times, as investors in Tesco (LSE: TSCO) need no reminding. Its shares are now 60% lower than they were five years ago and still limping. Tesco was once the UK’s top grocery dog but it has been savaged by those German mongrels Aldi and Lidl.

If that wasn’t bad enough, it now faces a fresh challenge from an internet thoroughbred Amazon (NASDAQ: AMZN.US) which has just launched its nationwide same-day grocery delivery service Amazon Pantry. Will the new service gobble up what remains of Tesco’s growth prospects?

Perish The Thought

Amazon’s Pantry will be stock with 4,000 food and household goods at launch. The service will be open to its Amazon Prime customers who pay a £79 annual subscription and is clearly designed to get more of them to sign up. Customers will also pay £2.99 for the first 20kg box they buy, plus 99p for any further boxes in the same order. The service already operates in the US, Japan and Germany.

It was originally thought the service would be called Amazon Fresh, as in the US, but in fact Amazon will only start off by selling non-perishable items. So the initial challenge isn’t quite as fruity as Tesco feared. Its offer of “Everyday essentials at every day sizes” includes breakfast cereals, jams and spreads, sauces and ready meals, pasta and baking supplies, and cleaning products.

Best Served Cold

That makes it a good way to stock up on bulky items, but customers will still need to go shopping (either at the high street or online) for milk, fruit, vegetables, meat and other perishable essentials. Why would they bother doing two shops — and possibly incur two delivery fees — unless Amazon can prove it is much cheaper? This isn’t the mortal challenge we all fear, although nobody can write off Amazon.

Amazon has deep pockets and seems willing to invest in the cold chain capability it needs to offer fresh food deliveries, buying two Tesco logistics buildings in the London area, and trialling chilled and frozen food delivery in Birmingham. There is a long way to go, and although Amazon will eat into some Tesco sales, it will be a long time before it can deliver the same vast range of goods as Tesco. Until it has that kind of scale it may struggle to compete on price in the UK’s cut-throat grocery sector.

Dog’s Life

Tesco has more pressing problems. Sales fell 1.8% in the last four weeks, according to latest figures from Nielsen, even before Amazon opened its pantry. It has some friends, however. Citi has just upgraded Tesco to buy, with a target price of 230p, which would be a rise of 22% from today’s 170p. It reckons Tesco “has the scope to be more competitive, to rebuild its profitability and to repair its balance sheet”.

With shares near a 10-year low reckons things can only get better, Citi says, provided Tesco invests up to £700m to put the bite on the discounters. Tesco can worry about Amazon tomorrow. Aldi and Lidl are the ones snapping at its heels today.

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Harvey Jones has no position in any 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.