The AO World (LSE: AO) share price is down by 20%, as I write, after the company warned its profits are expected to fall sharply this year.
AO says that driver shortages, supply chain issues and rising costs are to blame for this situation. I expect many of these problems to ease next year — so with AO stock down by 75% so far this year, should I start buying the shares for a potential recovery?
What’s gone wrong?
Seven weeks ago, AO said sales were expected to rise by around 5% for the year to 31 March 2022. Underlying cash profits were expected to be between £35 and £50m.
Today, this profit guidance has been slashed to just “£10m to £20m”. Sales for the full year are now expected to be flat, at best. They may fall.
Management’s comments suggest the business has been hit by a perfect storm of problems. New capacity added to support future growth has pushed up costs. At the same time, driver shortages and supply chain issues appear to be causing stock shortfalls.
Worryingly, AO also reports “significantly increased competition” in Germany — a key growth market.
What puzzles me is that the outlook has worsened so quickly. Were none of these problems visible in October? I wonder if underlying consumer demand has also weakened.
A Buffett buy?
Warren Buffett once said that “the best thing that happens to us is when a great company gets into temporary trouble. We want to buy them when they’re on the operating table”.
So is AO a potential Buffett stock? Let’s take a look.
I believe that the troubles affecting this business will be temporary. AO could also have the makings of a good company. After all, the group’s sales have risen by 177% to £1,661m since 2016. I don’t see any reason why it can’t continue to grow once the supply chain situation stabilises.
Despite this track record, I don’t think AO is the kind of business Buffett would buy. Customers might like its offer but, in my experience, its only real attraction is low prices.
Ultimately, AO competes with larger retailers to sell identical boxed goods in a very competitive market. As a result, profit margins are slim. Last year’s record sales of £1,661m generated a net profit of just £18m.
Such low margins suggest to me that AO has very little pricing power and few competitive advantages over rivals.
Are AO shares cheap?
At the time of writing, its shares are changing hands at 97p. That’s a level last seen in May 2020, before the stock surged to a record high of 444p in January.
Has today’s share price crash left AO looking cheap? Based on today’s guidance, I expect the company to report an after-tax loss this year. Looking ahead to the 2022/23 financial year, I estimate the stock might still be trading on 20 times forecast earnings.
That doesn’t seem cheap to me. Indeed, I believe AO shares are still priced for growth.
This business could surprise by delivering strong growth next year. But the company’s profitability is too fragile for my liking. It’s not a share I would buy for my portfolio.
