In the long run, being a shareholder in online white goods retailer AO World (LSE: AO) has been unrewarding. The share price is down by 48% over the past five years and the company does not currently pay dividends.
But the shares have soared lately, almost doubling from their August lows. Positive news released this morning sent the shares up in early trading. Given the upward momentum of the stock in the past few months, might it have turned a corner? If so, ought I to add it to my portfolio?
Business challenges
As an online retailer, AO World saw sales boom during the pandemic. Revenue in its financial year ended in March 2021 was 62% higher than the prior year. Post-tax profits soared over 2,400% to £17m. Last year, however, things came down with a bump. Revenue fell, although it was still around 50% bigger than before the pandemic. The company crashed to a post-tax loss of £30m.
With recession biting, white goods sales could fall. That risks further slides in revenue for AO World, with a risk to profitability. I think that explains why the shares fell to the sorts of prices we saw over the summer.
Investor confidence seems to have increased since then however. I reckon today’s trading announcement could boost it further. The company said that revenue for the first nine months of its financial year was in line with its expectations, despite falling 17% compared to the equivalent prior year period.
The company said today it is “cautiously optimistic” and expects adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) of £30m-£40m, an upgrade from its most recent guidance issued less than two months ago.
Strategic choices
Ultimately as an investor, I prefer a company to make bigger profits on smaller revenues than the other way around. The firm’s decision to slim down its business to try and improve profitability – for example by closing its German business – appears to be yielding results.
However, as an investor, I pay little attention to EBITDA as an earnings measure. Interest and tax are real cash costs that businesses face. So I will be looking to see whether the company can successfully boost its basic earnings this year, hopefully turning a profit again.
Can the shares keep rising?
If the company can indeed prove its revised strategy is helping profitability then I think the AO World share price could keep rising. Despite almost doubling in a matter of months, I think the company could justify a higher valuation if it proves that its business model can be more profitable.
Although a recession could hurt sales, long-term demand for white goods should be strong. AO World benefits from a large customer base and well-regarded brand. I think the shares have turned a corner in recent months. I would be surprised to see them fall back to their summer lows if the current business momentum continues.
For now though, I will not be adding the company to my portfolio. Its business performance has been uneven. I still see AO World as a recovery story. I will wait for more evidence of sustained profitability before considering whether to buy the shares.
