Investors beware: these 2 online operators could sink even further

I’m a big fan of pureplay online retailers. Their asset-light business models and ability to respond to sudden changes in market conditions allows them to neatly sidestep many of the issues faced by those businesses with a significant high street presence.

Despite this, investors should still proceed with caution. For every and ASOS there will be many that struggle for a variety of reasons. Here are just two that I believe are examples of the latter.

Dragged down by Europe

Earlier this week, shares in £591m cap electrical retailer AO World (LSE: AO) tumbled following the release of its latest full-year figures to the market.

To recap, while UK operating profit rose 25.9% to £15.6m, operating losses in Europe climbed to £27.6m (from £23m in 2016) as the company attempted to gain traction in the continent through significant investment in the Netherlands and Germany. Overall, the company reported a group operating loss of £12m — a 13% increase on the £10.6m recorded in 2016.

To make matters worse, the Bolton-based company also stated that the UK trading environment remained “challenging” and that its Q1 growth rate was expected to “slow significantly year on year“. 

A quick glance at AO World’s financials makes for fairly depressing reading. Free cashflow looks awful, operating margins woeful and — as might be expected from a company with a high growth strategy — there’s no dividend to speak of. 

To make matters worse, as inflation begins to bite, wage growth declines and Brexit approaches, it’s not unreasonable to suggest that cost-conscious consumers will delay purchasing the sort of goods AO World supplies. Even distressed purchases (such as a replacement washing machine) won’t be enough to save the company from further pain – particularly as I see no reason for customers to automatically turn to AO World over any other retailer. It’s a firm SELL for me.

The stuff of nightmares?

Recently listed mattress, pillow and duvet retailer eve Sleep (LSE: EVE) is another company that won’t be finding its way onto my wishlist.

Since coming to the market in May, shares in the small-cap have dipped 6%. Although it’s still early days, this reaction does suggest that investors are concerned by the lofty £140m valuation slapped on the lossmaking business when it listed.

To be clear, I’m not averse to investing in lossmaking companies so long as their future prospects look sufficiently bright. Think robotic automation software provider, Blue Prism and online estate agent Purplebricks

No, my concerns with eve Sleep can be summarised in a few questions. Why shop for bed products at eve when there is far more choice available at competitors? And even if you are impressed by the company’s products, how often are you likely to return as a customer? I doubt many people replace their mattresses on a regular basis. Lastly, what is eve doing to truly disrupt the industry? It’s this combination of a lack of product differentiation and a need to consistently find new customers (rather than rely on repeat business) that make me bearish on the stock.

Not all online operators are created equal, particularly if the product(s) being sold can be replicated with ease or purchased at a lower cost elsewhere. As such, I think investors should steer clear of AO World and eve Sleep for some time to come. 

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.