AO World's (LON:AO) strategic decisions to streamline the business and focus on profit and cash generation are beginning to wash through.
An impressive update, which included an upgrade to the full-year profit forecast, showed particular promise in its dominant retail business. Adjusted pre-tax profit is now expected to be within a range between £39 million and £44 million, compared to previous guidance of £36 million to £41 million, with revenues also upgraded and likely to come in between £1.09 billion and £1.13 billion.
The previous decisions to exit the German business and remove its non-core channels and loss-making sales were difficult but necessary actions. To add to the challenge, these were compounded by a weakening of consumer sentiment, as well as a slight shift away from online purchases as customers reverted to physical shopping, where the likes of rival Currys (LON:CURY) have an edge given its store portfolio and indeed overseas presence.
Even so, the group’s lack of a store portfolio means that in comparison to more traditional retailers, AO World is a relatively capital-light business, and its warehousing operations are also largely owned by the group. The group is now concentrating on these overheads having previously streamlined its operations, with a third-party warehousing solution going live in April, while at the same time, a decision to implement delivery charges on all orders boosted service revenue without a material impact on sales.
The group is now fully focused on cash and profit generation, underpinned by its core UK sales of Major Domestic Appliances (MDA), where the group is squeezing its advantages wherever possible, while also considering other appliance avenues of growth. In addition, AO World now offers ancillary services such as installing new products and recycling old ones, in an overall addressable market in the UK which the company believes to be in excess of £28 billion. In terms of UK MDA overall, the company estimates a market share of 16.4% from the previous 15.8%.
Indeed, the consumer retail business, whose revenues account for 75% of the group total, increased by 13% to £382 million, despite weaker consumer demand and lower pricing. At a group level, revenues rose by 6% to £512 million, with adjusted pre-tax profit jumping by 30% to £17 million. There were also notable improvements in other key metrics, such as an increase in free cash flow from £3 million to £14 million and net funds rising from £16 million to £38 million. Efficiency savings more than offset lower pricing, which resulted in the gross margin edging up from 23.5% to 24.4%.
Of course, keeping the brand in mind comes at a cost, and advertising and marketing spend rose by 13.6% to £19.7 million. However, this number equates to just 3.8% of overall revenues and is also subject to a different focus, with less of a concentration on traditional TV advertising as the group explores the likes of video on-demand and out-of-home advertising as alternatives. The slightly unusual acquisition of musicMagpie may have raised some eyebrows as the synergies were not immediately obvious, but AO World is the thinking that it will gain additional exposure to mobile and consumer technologies at a relatively low cost.
The numbers are not a complete slam dunk, however, and in particular, the mobile business needs some care and attention. The unit is currently loss-making due to soft consumer demand and a fall in connections, While the business represents a relatively small part of the overall group income, AO World is continuing to run with its potential and to provide additional sales channels, the group acquired two web domain names in the period, with the strategic focus being on selling its full range of its products to its customers. At the same time, the group will be acutely aware of competitor activity in its space and its overall focus should sharpen its appeal. In addition, AO World is estimating an annual hit of £8 million as a result of the recent Budget announcements.
The general tone at AO World is upbeat, and the group is now moving into peak trading with its range of Black Friday offers gaining traction. The shares have reacted positively to the company’s refocus and have risen by 33.5% over the last year, as compared to a gain of 12.4% for the wider FTSE 250. The price may remain some way off the peak of around 430p at the height of the pandemic in January 2021, when perceived prospects for the company were at heady heights. Even so, on a valuation basis the shares are at a level which is undemanding historically, and the scale of significant progress which has been made leads to a market consensus which remains at a buy on growth prospects.