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Why is the AO share price crashing?

Image source: AO World

The AO (LSE:AO) share price has lost 40% of its value in the year to date. It’s now almost exactly the price it was back in October 2020. 

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CEO John Roberts set up AO as a result of a £1 bet in a Bolton pub. The business sells appliances online, as its original name suggests. Now it’s a £1.2bn giant with operations in the UK and Germany.

AO share price trading up

Let’s have a look at a recent FY21 trading update from the FTSE 250 electrical retailer.

The company says it delivered a “strong performance” in the last 12 months, adding 2m new customers. This includes “significant increases in revenue, a step change in profitability at both group and divisional levels [and] strong cash generation”. All without taking any government assistance in the form of a Covid-19 business loan.  

Revenues jumped 62% to £1.66bn overall, and generating net cash of £57m across the year is £80.4m better than 2020’s £23.4m net debt!

The company’s German arm, launched in 2014, is also expected to turn a profit this financial year. That’s better news than in 2019 when Roberts was forced to close his Dutch operation. He said at the time that AO World could expand further internationally once the German model was proven. 

So sales are good, cash looks strong, and the overseas experiment is finally working, it seems.

So why does the AO share price look like it’s falling apart? 

[fool_stock_chart ticker=LSE:AO]

Online to offline

The AO share price quadrupled in 2020. That’s probably part of why it’s falling now: as countries reopen, an online-only play is overvalued. The business saw strong demand as people were forced to stay indoors through the Europe-wide lockdowns. And Roberts is betting that online is now the dominant channel for customers, and says that the company’s market has “changed as a result, forever”.

I can see why Roberts thinks this way. During the pandemic, my elderly parents started buying online and having their shopping delivered. They realise now first hand how easy and cheap it is. And there is no way they are going back.

But the world’s focus right now is on optimism. High streets — and therefore rivals — are opening up. 

Still, as a contrarian value investor, I’m seeing some new opportunities in this switch in market focus. The AO share price might just have fallen out of favour, temporarily.  

The risk of buying here is that retail hasn’t, in fact, changed forever. “I expect that we will continue to be a double-digit growth business in the year ahead,” the CEO says. The AO share price could crumble if sales fail to meet these pretty spectacular targets. 

The other fly in the ointment is an increase in warranty plan cancellations, mentioned in AO’s Q3 results in January. The business is forecasting a one-off cash reduction of around £15m. That’s a hit to profits, right there. I’ll probably wait to hear more details, expected in the full-year results due on 16 June 2021. But I’m watching this one closely.

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TomRodgers has no position in any of the 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.

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