Electrical appliance retailer AO World (LSE: AO) has been on a losing streak lately. Shares have fallen a quarter from where they stood this time a year ago.
Below I consider the bull and bear case for the AO World share price, and my view on whether it can recover.
AO World: the bull case
AO World is a fast-growing online electric appliances retailer. Ignoring for a moment a surge in demand during last year’s lockdown – which I’ll discuss below – the company’s recent half-year trading statement showed revenues 66% higher than two years ago. Not only did the company’s core UK market do well, growing 63%, its German operations did even better. German revenue rose by 84%.
The company has also managed to turn revenue growth into broadly improving financial performance. Last year, for example, AO World grew its group profit before tax to £20m. It generated £60m in cash, and reduced net debt to £28m versus £99m the prior year.
It also attracted over 2m customers during the year. Online retail is known for being a tough business, in which it can be hard to make a profit. That is partly due to strong price competition thanks to the ease of online price comparison. AO World has proven it can make a profit, with earnings per share last year of 3.7p.
I think the company can continue to grow. Large electrical appliances and white goods such as washing machines can be heavy and bulky, so the economics of selling them and delivering them help keeps competition lower than in some areas of online retail. Plus, AO World’s strategy of differentiating itself through customer service could help set it apart from some online retailers.
A bear case on AO World
So, why has the AO World share price been crashing?
First is a feared pandemic effect. Although sales soared last year, some analysts reckoned that was only due to lockdowns, which led to people buying items online for their homes. I understand that concern. But even compared to last year’s first half with its lockdowns, AO World reported revenue growth of 6%.
The shares also look expensive on a valuation basis. Even with earnings per share of 3.7p, the AO World share price still trades on a price-to-earnings ratio of 44. That looks expensive. If earnings continue to soar, the prospective price-to-earnings ratio could be much lower, but for now we don’t know if earnings will indeed keep growing quickly. While earnings before interest, taxes, debt, and amortisation (EBITDA) isn’t the same as profits, the company has guided that EBITDA is likely to fall from £64m last year to £35m-£50m this year. That does not suggest a company in profit growing mode. It helps explain why the shares crashed 24% on Friday after the trading update.
I believe the AO World share price can recover
Is this fall a buying opportunity for my portfolio?
AO World has demonstrated over the past couple of years its ability to scale at speed. I think it can continue growing. So, if future results are stronger than expected, I think the AO World share price can recover.
But the valuation looks high if future profit growth doesn’t materialise. There is a risk it won’t, as this year’s earnings guidance shows. So I am not buying AO World for my portfolio.