AO World returns to profit but warns on consumer spending pressures

Online electricals retailer AO World (AO.) returned to profit on the back of cost efficiencies and streamlining, despite revenues falling by almost a fifth. The company reported in line with pre-close guidance after implementing a strategic shift as it tries to drive much-needed profit and cash generation.

AO World exited business lines, stopped trading in Germany, ended its trial with Tesco (TSCO) and contracts with housebuilders, implemented “significant” layoffs focused on senior and middle management roles, and introduced delivery charges for all orders. Cost-cutting helped its gross margin, which was up by 160 basis points to 20.9 per cent, as the cost of sales fell by £205mn.  

One result of the change in direction was the big contraction in revenues, however. Product revenues, which contribute three-quarters of the company’s sales, were down by 22 per cent to £875mn. But this wasn’t just due to strategic changes and action on profitability – the company also flagged that “the impacts of the cost of living crisis on consumer spending” hit performance in its key division. Top-line growth was posted in the smaller services and third-party logistics divisions, but commission and recycling sales also fell.

Elsewhere, the company said that the annualisation of savings should offset inflationary pressures and help it to keep its administrative cost base of £226mn flat in 2024.

AO World entered a “strategic partnership” in June with Mike Ashley’s Frasers (FRAS), which has built up a 22 per cent stake in the business, and is now its biggest shareholder. The retail tycoon won’t be pleased to see that the market wasn’t blown away by these results, based on the flat share price, but there was certainly strategic progress made. 

Despite that, there were no guidance updates. Management is trailing a 5 per cent cash profit target in the short term and revenue growth in the medium term.

Broker Shore Capital said that minnow Marks Electricals (MRK) “offers better value” in the same retail space, with a free cash flow (FCF) yield of 6.1 per cent and an 11 per cent FCF compound annual growth rate for 2024. That company is one to watch, but despite better opportunities elsewhere, there is also life in AO World yet, with Mr Ashley’s manoeuvres something to keep an eye on. House broker Numis forecasts cash generation of £30mn-£40mn in each of the next three years and a less demanding price/earnings ratio of 16 times for 2025. Hold.

Last IC view: Sell, 61p, 23 Nov 2022