AO World, the recently floated online retailer, has dipped following a sell note which says the company's shares would be overvalued even if it was responsible for every domestic appliance sold in the UK.
Starting coverage on the company, Shore Capital analyst Michael Stewart said:
AO World is a fabulous online retailer to our minds with an excellent founder/leader. However, at a price of 271p per share, a near 61% premium to what we estimate to be fair value, we initiate coverage on AO with a sell recommendation. The group has a bright future but Shore Capital's message to potential investors is to avoid the stock at current levels. If an eye-watering valuation is not enough to curb enthusiasm for the stock then low returns, margin headwinds and potentially risky earnings certainly should be; no dividend is forecast.
He elaborated his reasons:
A tough market to operate in: Selling domestic appliances is a capital-intensive, low-return activity. The consumer has limited brand loyalty in this market, price competition is incredibly high and demand is elastic.
For the bulls out there who believe that the online penetration rate will continue to rise and AO will continue to gain market share, consider the following: if the online penetration rate reached 100% and AO sold every single major domestic appliance in the UK, the stock would still trade on a PE multiple of 22 times in our analysis.
Product protection plans: Whilst AO may well be profitable without selling protection plans it certainly would not be as profitable – commission earned from selling product protection plans forms a material proportion of earnings (around 50% of adjusted EBITDA in 2014) and in our view their contribution to earnings was the difference between a profit and a loss in 2012.
Margin headwinds: According to Bloomberg, the market is forecasting an EBIT margin of 4.3% for the group in 2017, some 60 basis points above our estimate. The market, in our opinion, has massively underestimated the impact that continental Europe will have on the group's margins and investors should be aware of this.
Our discounted cash flow analysis shows that the intrinsic value of the firm is 173p with continental Europe contributing 30p towards this value. Sell.
In the market, AO shares are down 4.1p at 267.1p. It floated in February at 285p a share.
