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Why Ocado Group plc Could Go Through The Roof If, Inc Buys It

Shares in online grocery retailer Ocado (LSE: OCDO) shares are shooting up after the Daily Mail reported that Inc (NASDAQ: AMZN) might be taking over the company. For months now, the two parties have been tipped as partners for imminent betrothal, none of it as yet officially confirmed.

Could this be the tipping point?

Last year, the company badly underperformed both the FTSE 100 and the FTSE 250 with Ocado’s misfortunes to a large extent based on the threat of competition from Amazon’s newly-launched grocery delivery arm Pantry.

Fundamentally Ocado is a healthy company with a modest profit. It was voted best online supermarket by Which? and provides customers with an excellent experience thanks to impeccable delivery logistics.

Takeover is good news

Already, various analysts, including Credit Suisse and Goldman Sachs, hypothesise that Ocado would benefit from a takeover by Amazon that would give it strong backing and multinational status.

The two companies essentially offer the same service, even though Amazon’s Pantry doesn’t have a complete assortment of both dry and fresh grocery items in most UK areas, something that Ocado does boast.

Amazon’s short track record in delivering groceries isn’t perfect. Rob Joyce, a Goldman Sachs analyst, says that Amazon either ought to license Ocado’s website and delivery structure or have the company deliver Amazon’s goods, both of which make sense.

Despite the share spike (the company yesterday soared 11% at one point) to £2.57, the price is currently barely above the level it fell to late last year when Amazon’s CEO Chris North commented in the Guardian that Pantry would extend its range of grocery items. Ocado’s share price slid around 8% on that news.

Of course Ocado wasn’t the only sufferer from Amazon’s foray into groceries. J Sainsbury fell 1.2% on the news, Tesco 0.4%, and Ocado partner WM Morrison lost 1%.

Ocado’s Achilles heel

However, investors did punish Ocado much more severely. Selling volumes reached above-average numbers, which hammered the stock. The rationale was that Tesco and Sainsbury have physical stores as their bread and butter. But Ocado’s online reliance meant that it could easily fall victim to Amazon’s expansion, with the US giant having shown time and again it can eliminate rivals in many sectors.

Amazon outfoxed?

Obviously this realisation was going to be detrimental to the Ocado share until something better happened. With a P/E of 234, it’s difficult to justify an investment, certainly if the long-term prospect of a company is being undermined.

But we live in a rapidly changing world and you could argue that there have been enough instances in Amazon’s global history where it too was outfoxed. Looking at examples of this (Alibaba in China and Flipkart in India) you can see that Amazon suffered mostly when it encountered rivals with a strong foothold in a market. Ocado has that in the UK, where online grocery shopping penetration is 6%.

In the UK grocery sector, Amazon has yet to make an impression. Everybody knows that deliveries can really mess up online purchases and when it comes to feeding the family, who would want to rely on a less-than-perfect delivery system?

Certainly if a deal is on, I would put some money in Ocado. The difficulty is to know whether this is really on the cards or not.

For the time being, the UK stock market offers other excellent opportunities for serious growth investors this year.

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