City analysts are rarely so frank. All too often, they seem to succumb to the temptation to hold back their harshest words about the companies they cover, for fear of being denied access to senior management and losing touch with the corporate nuances they need to publish accurate research.
Not so Greg Lawless at Shore Capital, who didn’t hold back yesterday when he repeated his “sell” recommendation on AO World. Mr Lawless said that he found himself in a “perpetual downgrade cycle” with the online electrical appliances retailer, as he savaged his profit forecasts for the next two years.
AO World is subscale in its presence in Europe, is facing slowing growth and meatier competition in its core British market and will suffer pressure on its margins from some of its newer product offerings in the UK, he said. Despite the likely earnings boost from AO World’s recent £32.5 million acquisition of Mobile Phones Direct, an online-only retailer, Mr Lawless cut his profit forecast for next year from £3.8 million to just £800,000 and for the following year from £20.7 million to £11 million.
AO World was launched 17 years ago by John Roberts, its chief executive, as Appliances Online, selling white goods such as fridges and freezers over the internet. Rebranded in 2013 and listed on the stock market the following year, the retailer, now rather more diversified, also sells smaller goods such as hairdryers and coffee makers and operates in continental Europe as well as Britain. It also makes money from the sale of warranties on some of its goods.
Its life on the stock market has been difficult from day one. AO World and its bankers set the price of the shares in the float at 285p, giving a £1.2 billion initial valuation to a business that the previous year had made pre-tax profits of only £8.7 million. Not only was the prospectus providing more financial details about AO World not published until after the price had been set, but the shares were allocated across a small group of investors. This meant that a wide group of shareholders missed out on the benefits of a 33 per cent rise in the price on the first day. The shares have since gone into reverse, not helped by a profit warning a year after the listing, but rose a penny to 127p yesterday, giving AO World a more humble value of £582 million.
AO World’s problems have several sources. The sharp decline in consumer confidence since the Brexit vote has meant that householders are more wary of splashing out on higher-margin, big-ticket ovens and fridge-freezers. And the company is linked to the housing market, which also has been in decline, reducing the chances of homebuyers upgrading their domestic goods when they move.
In the background, some in the investment community have raised questions about the way that the retailer accounts for the earnings it receives from warranty sales, effectively booking the income it expects to receive in future years in one go at the beginning of the contract. AO World is required under accounting standards to do this. While it raises the concern that at least some of that revenue would be in jeopardy if customers cancel their warranties early, the company tempers this by discounting its booked income based on the likelihood of this happening.
The moves to diversify that AO World has undertaken look intelligent. However, the wider economic backdrop makes a loss-making AO World unattractive. With no prospect of a dividend in the short term, there seems to be little reason to own the shares.
ADVICE Avoid
WHY A shrinking, increasingly competitive market closely linked with consumer sentiment is unlikely to improve in the short term
Cohort
Cohort has given its shareholders plenty to think about. The technology group that specialises in defence unveiled a pre-tax loss for the first half, but was so confident about its ability to move healthily into the black by the end of the year that it declared an interim dividend 12 per cent higher than last time at 2.85p a share.
That means, incidentally, that it has to book almost 90 per cent of its annual pre-tax profits during the six months from the beginning of November to stand a chance of making pre-tax profits for the year of about £15.8 million, according to an estimate by Investec.
Cohort also hit investors with a potentially transforming acquisition, agreeing to pay up to £41.9 million to buy Chess Technologies, a specialist in tracking and fire-control systems for the armed forces. It will be run as Cohort’s fifth standalone subsidiary.
Cohort was set up, and floated on the Alternative Investment Market, in 2006. It operates four businesses. Mass specialises in electronic warfare and cybersecurity, with customers including Transport for London; MCL designs surveillance and communications systems and is a large supplier to the Ministry of Defence; SEA develops systems and software, including torpedo launchers for the Royal Navy; and EID is a Portuguese business that designs and makes communication systems used by navies in the Philippines, Portugal and Australia.
Cohort’s first-half results offered plenty of comfort. Revenues and hence profits fell by more than 10 per cent in the six months to the end of October, mainly owing to delayed orders; but its order book at the end of November was £135.4 million, £26.6 million higher than a month earlier. Orders in train are expected to generate more than £50 million in revenues before the year is out. The Chess acquisition gets Cohort into radar systems for drones and a slot on the navy’s new Type 26 frigate. The cash payment upfront is £20.1 million, the targets for the extra payments are tough and Chess will improve earnings immediately.
Cohort’s shares, off 5p at 410p, trade at 13 times forecast earnings for a yield of 2.2 per cent. There is plenty of long-term potential.
ADVICE Hold long term
WHY Rounded, gradually expanding business that should grow over time
