AO World's pandemic headaches ease

After soaring during the pandemic, online electronics retailer AO World (AO) has come crashing down to earth in the last two months. In October, it forecast adjusted cash profit (Ebitda) of between £35m and £50m for the full year, with profits more heavily weighted towards the second half of the year. Only seven weeks later in its half-year results, it revised its cash profit forecast down again to between £10m and £20m.

The issues are the same ones we have been hearing about for months from online retailers. Management has pinned the blame on “supply chain challenges”, including lack of availability in certain appliances, plus increases in shipping costs and input prices. The rising costs caused a swing from a pre-tax profit of £18m last year to a pre-tax loss of £10m this year. These costs should eventually moderate, although the timetable is difficult to gauge.

Although there is already some evidence to suggest that shipping costs are starting to come down, the bigger problem is that a lack of product availability is hitting the top line. Full-year guidance now has revenue decreasing by possibly as much as 5 per cent. The best news from these results is the gain of 780,000 new customers, but if it can’t service them properly they may soon drift away, particularly given the rise of online retail competition during the pandemic.

The optimists will point to the pre-Covid comparison. In the last two years, revenue has increased 67 per cent, with the UK up 65 per cent and Germany up 82 per cent. Customers are also repeat purchasing with increased frequency. The hope will be that AO World can keep these customers around until the supply chain costs start normalising.

A concern, though, is that the company isn’t benefiting to any sizeable degree through economies of scale – at least not yet. Although sales have increased, administrative expenses as a percentage of total revenue have risen 4.3 percentage points to 20.4 per cent. This is primarily due to an investment in new people, and a rise in marketing costs needed to compete for market share as more retailers move online, especially in Germany.

The FactSet consensus is for EPS to rise to 5.18p in 2024, fractionally above 2021 and well above the loss of 0.9p in 2019. This suggests brokers believe the increased consumer numbers leave it in a better position than before the lockdowns, customer loyalty aside. 

AO World operates on a relatively modest gross margin of only 19.7 per cent, which meant the increase in costs was going to mean a big hit to profits. Until it finds a way to manage its costs more efficiently the outlook remains a little gloomy, but this seems priced in given the recent fall in market cap. Hold.

Last IC View: Hold, 254p, 1 July 2021