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AO World PLC Crashes On Profit Warning: At What Price Should You Buy?

Shares in online white goods retailer AO World (LSE: AO) opened down by a staggering 47% this morning, before recovering somewhat to currently trade around 30% below last night’s closing price.

The trigger for this collapse was a profit warning from AO, which said that revenue and earnings growth for the current quarter and the full year were likely to be lower than expected.

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AO said that full-year revenue is now likely to be £470–475m, around 6% lower than expected, while profits are expected to be down, too, with adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) now expected to be around £16.5m.

What’s gone wrong?

In today’s profit warning, AO said that it now believes that the extra publicity surrounding its IPO last year helped to boost sales, but says this effect now appears to be wearing off, slowing sales growth.

AO also admitted that while Black Friday helped to boost sales at the time, it didn’t generate any extra sales. Instead, sales were simply compressed into a shorter timeframe than usual.

What’s the outlook now?

AO says that its board is confident that firm’s business model remains strong, with growth potential from the ongoing roll-out in Germany, and the introduction of audio-visual sales in the UK. However, I feel that investors need to consider some other aspects of the business, in order to gain a balanced view.

Competition in this sector is vicious, and is always led by price. AO’s first-half operating margin of just 2.5% demonstrates, in my view, how difficult it will be for the firm to make meaningful profits. Indeed, AO seems to be struggling to make any profit on appliance sales: during the first half of the year, website sales of £173m were actually lower than the firm’s cost of sales, which was £176m.

My reading of AO’s accounts suggests that only £34m of ‘third-party website sales’ — extended warranties and insurance policies — helped lift the firm to an overall profit.

What are AO shares worth?

Before today’s profit warning, AO shares were trading on around 90 times 2016 forecast earnings per share. This was clearly excessive.  Even if we assume that the firm will hit 2016 forecasts for earnings of 3.1p per share, I can’t believe that the shares are worth any more than perhaps 120p — a 2016 forecast P/E of around 40. 

You may not agree with my cautious view on AO World, but today’s profit warning highlights the importance of doing your own research — and ensuring that you understand why you are buying a stock, and why you believe its value will rise.

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Roland Head has a short position in AO World. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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