A share tip circled in a newspaper share listing

Forget AO World’s mission to “redefine retailing” — it’s not the next Amazon and is grossly overvalued

Disclosure: I have no financial interest in any company mentioned in this article.

John Roberts, chief executive of online electrical retailer AO World declared today that the company is continuing to deliver on “our mission to redefine retailing”.

As far as I can tell, this simply involves undercutting the competition and making no profit. Mr Robert’s claim that by investing in marketing and undercutting the competition he will improve repeat business is nonsense, in my view.

Customers don’t show loyalty to a box shifter like AO, they just buy their next washing machine or fridge from wherever’s cheapest. If AO is always cheapest, it’s mostly because it appears to have abandoned all intent of making a reasonable profit.

Let’s look at some of the key numbers from today’s interim results:

  • Group revenue was up 21.7% to £264.3m
  • Group operating loss of £8.9m (versus £0.9m profit for HY2014)
  • Net funds down to £29.6m (HY2014: £43.9m)
  • Loss per share of 1.58p (HY2014: earnings per share of 0.12p)

The losses are of course blamed on expansion, specifically the investment in German growth and startup in new European territories, such as the Netherlands. So can we assume that AO’s UK operations are churning out free cash flow to fund this largesse? Sadly not:

AO World 2014H1 results summary (courtesy of investegate.co.uk)

AO World 2014H1 results summary (courtesy of investegate.co.uk)

Note that AO’s adjusted EBITDA margin — the most generous and flexible measure of profitability that exists — tumbled from 3.4% last year to just 2.0% during the first half of this year. As a result, AO’s adjusted operating profit for UK operations fell by 44.7% to just £3.1m on £248.6m of sales.

Interestingly, share-based payment charges only fell by 3.5%, from £1.3m to £1.2m. It’s good to know that 39% of the adjusted operating profits from AO’s only profitable division are being used to enrich senior management with stock options.

In a sense, though, my problem isn’t with AO’s thin profit margins. This is a tough business. For comparison, Darty reported a group operating margin of 1.7% last year, making £14.2m of post-tax profit from £3,512m of sales.

The problem is that AO is sub-scale and massively overvalued. Darty is valued on a forecast P/E of around 19, falling to 15 in 2017.

AO, which has sales of just 14% those of Darty, is valued on a 2017 P/E of 103 and continually pushes back the date at which it expects to make a profit. Consensus forecasts for 2016 earnings per share have fallen from 4.2p 12 months ago to -0.29p today.

Darty is valued on a price-to-sales ratio of 0.22. That’s reasonable for a firm with such low margins.

Why then, is AO valued on a P/S of 1.44? AO’s market cap of £686m is actually bigger than Darty’s £520m market cap…

Still a sell

I would add that I’ve been a customer of AO World over the last year. When we replaced our kitchen we bought a number of our appliances from the firm, benefiting from some kind of discount code and cashback offer which made them much cheaper than anywhere else.

The service was good, although we did get a telephone call a few days later giving us a the hard sell on an extended warranty agreement. Needless to say I said no, as despite the headline appeal of a promised lifetime new-for-old replacement policy, the policy on offer was far too expensive to make sense.

I suspect this is where what little profit the firm makes comes from.

The shares are grossly overvalued and remain a sell, in my opinion.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Shoe shop

Why I’ve sold Shoe Zone

Shoe shopDisclosure: I have no financial interest in the companies mentioned in this article.

Having commented positively on Shoe Zone’s recent year-end trading update, I’ve now sold the shares. After costs and including dividends, I’ve banked an 18% profit in five months.

There were several reasons for my decisions to sell.

1. Limited upside

Although Shoe Zone is a cash generative and profitable business, I’m not sure how much upside there really is. The group’s store network is already quite large and now is being right-sized and optimised, rather than expanded.

The shares have gained around 15% since my purchase and started to look more fairly valued, in my view, especially as broker forecasts have been moving steadily lower.

Shoe Zone now trades on a 2015 forecast P/E of 13.3, falling to 11.3 in 2016. That seems about right to me.

2. Director sales

My feeling that the stock is now fully priced was confirmed by the recent director sales. Founding brothers Anthony and Charles Smith (CEO and COO respectively) sold nearly 2.5m shares. This netted them £4.74m and took their combined holdings down to just a fraction over 50%.

In other words, they sold as many shares as possible without losing control of the company. That feels a little bit like having the Smiths are having their cake and eating it. As a small shareholder, I’m not entirely comfortable with this.

3. Better buys elsewhere?

My final reason for selling was to free up some cash to make some other stock purchases. I have my eye on a share I believe could have much more upside potential than Shoe Zone.

I also want to average down on one of my battered commodity stocks.

Of which more shortly…

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.


Stanley Gibbons Group: dreadful results, uncertain outlook

StampsDisclosure: I have no financial interest in the companies mentioned in this article.

Having been bearish on Stanley Gibbons for more than a year now, I thought I should comment on the firm’s latest interim results.

What a dreadful set of figures they were too.

Here are a few highlights:

  • Net debt up nearly 50% in six months, from £11.5m to £17.0m
  • Gross margin down from 57% in FY2014/15 to 48% during H1
  • Stamp sales down 40% to £9.1m
  • Trading profit margin on stamp sales down from 28% last year to just 4%
  • Interim dividend cancelled, final under review

The firm has now admitted that its relentless and costly focus on acquisitions has caused management to take its eye off the ball at the group’s core stamp division. Chairman Martin Bralsford has pledged to reverse this decline.

I agree that the acquisitions have been overly-ambitious and highlighted the risks of Stanley Gibbons multi-year acquisition spree here.

However, I’m not sure whether the firm’s decision to blame acquisition distractions is just a smokescreen for a slump in underlying demand for rare stamps. Is the China-led boom in rare stamp collecting running out of steam?

In fairness, the company says that this year’s auction calendar is weighted towards the second half of the year, so sales could/should improve.

As various commentators have pointed out, the shares now trade close to their net tangible asset value of 90p. In theory, this should provide good downside protection. Stanley Gibbons should be able to generate some postitive cash flow to reduce debt by selling off some of its stock.

I do have a few concerns about the practicality of this approach, though:

  • High value sales to the firm’s top 10 high net worth clients fell by 58% during the first half, compared to the same period last year. It seems likely that this is linked to the downturn in emerging markets, principally China. By the firm’s own admission, Trading performance in philatelic dealing is largely influenced by high value sales made to key high net worth clients.“.
  • Debt has ballooned dramatically and is now 4.7 times 2014/15 operating profits. Net cash outflow during the first half was £5.5m. Net cash outflow from operations and capex was £17.6m last year. How long will the banks continue to fund this state of affairs before they demand some cash generation?
  • Stanley Gibbons has £55m of inventory at cost on its balance sheet, but if the firm needs to use this to generate cash quickly and the market is soft, then big markdowns on normal retail prices may be required. This will effectively erode the firm’s NTAV, as it won’t be able to replace the stock on a like-for-like basis.

We’ll know more when we get a trading update for the second half of the year, during which the firm’s auction calendar looks busier.

In my view, this is a finely-balanced situation with little visibility for shareholders. Things could go horribly wrong, to the extent that a rights issue or placing may be required.

Alternatively, Gibbons could stop blowing cash on acquisitions and generate some cash instead, by delivering bumper H2 trading with strong sales of rare stamps and coins. Coins and medals are sold through Gibbons’ Baldwins business and appear decently profitable at the moment.

As far as I can see, good and bad outcomes seem equally likely, at best. That is why I still wouldn’t want to be long here.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

A tunnel in a deep mine

Lonmin enters last chance saloon with $407m rights issue

A tunnel in a deep mineDisclosure: I have no financial interest in any  company mentioned in this article.

Lonmin’s decision to raise $407m (£270m) through a 46-for-1 rights issue means two things:

  1. Shareholders who choose not to take part will be diluted out of existence — the number of new shares mean dilution will be 97.5%.
  2. If Lonmin cannot make this work, shareholders are toast; the company is likely to go into administration and the shares to 0p.
  3. The only people guaranteed to make a profit out of this are the banks underwriting the offer. They’ll be collecting a cool $38m in fees. That’s more than 10%. Nice work if you can get it.

Lonmin’s spectacular 95% discount to its stated book value has been a potent reminder of the writedowns and dilutive re-financing we all knew must be in the pipeline.

Since the rights issue was announced yesterday, Lonmin shares have continued to fall. As I write they are down by 35% on Tuesday and by 43% so far this week. Many shareholders have obviously decided that faced with a choice between a big loss and funding Lonmin’s third major rights issue since 2009, they will sell.

Here’s a summary of what the rights issue will mean. All these figures are estimates based on my calculations. Naturally they may contain errors and will rapidly become out-dated — please do your own research before making any investment or trading decisions:

  • Rights issue price: c.27bn new shares at 1p
  • Ex-rights price (based on last seen 10p share price): 1.2p
  • Estimated value of nil paid rights: 0.2p (i.e. 9.2p per existing share)
  • Estimated price/book ratio post-rights issue: 0.2

These numbers will change continually until the shares go ex-rights. If Lonmin shares continue to fall, the ex-rights price and the potential value of the nil-paid rights will fall further. In my view there is no reason to consider an investment until after the rights issue, when the flood of new shares hits the market.

Mucho problemo

On the face of it, Lonmin has a stronger balance sheet than heavily-indebted Petropavlovsk, which also carried out a massively dilutive rights issue earlier this year. Lonmin’s net debt isn’t excessive but the firm’s other problems make it potentially much more risky than Petropavlovsk, in my view.

The obvious issue is that the firm’s reported platinum group metals (PGM) basket price fell from $1,013/oz in 2014 to just $849/oz in 2015. In 2011, it was $1,300/oz. Can Lonmin restructure its operations in order to generate free cash flow at the current price? Perhaps, but the firm faces a wide range of obstacles.

This article by Reuters columnist Andy Critchlow does a good job of explaining the issues, but in brief Lonmin must deal with a weak and uncertain platinum market, labour-intensive, aging mines with a highly-unionised workforce, and the difficult political and social environment in South Africa.

After all, it’s only 3 years since 34 Lonmin workers at the firm’s Marikana mine were shot by police. The company was not found to have broken any laws, but was criticised by a subsequent judicial inquiry for not doing enough to prevent the outbreak of violence.

In my view, investors need to consider the nature of the problems that led to this tragedy, which would be inconceivable in most other parts of the world:

  • Is South Africa a safe investment environment?
  • Do you want to fund a company which has for many years been happy to profit from workers whose poverty and inequality drives them to such extremes?

Lonmin has been a toxic investment since at least 2012, in my view. I believe there’s still a fair chance the firm could go bust leaving shareholders with nothing. However, I will look again at the investment opportunity after the rights issue takes place.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Shoe shop

Shoe Zone provides solid year-end trading update

Shoe shopDisclosure: I own shares in Shoe Zone.

A solid pre-close trading update from Shoe Zone (LON:SHOE) this morning should mean that the forecast 9.4p total dividend is in the bag, giving a prospective yield of about 5%.

Although total sales are expected to have fallen from £172.9m to £166.8m due to net store closures, pre-tax profit is expected to be in line with expectations and net cash at the end of the year was £14.2m, a 56% increase on the same point last year.

That’s good news for shareholders, as it means that Shoe Zone trades on a cash-adjusted P/E of just 10.2, assuming Stockopedia’s broker forecast for earnings per share of 15.8p is correct.

I added Shoe Zone to my value portfolio in June and also took a close look at the company in my weekly Stockopedia column in September.

Naturally I continue to hold.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.