Panmure goes short on "grossly overvalued" AO World

Broker Panmure Gordon has begun its coverage on AO World with a 'sell' recommendation, arguing that shares in the white goods e-tailer are "grossly overvalued" and trading for double their intrinsic worth.

Since hitting a low in late October, shares in AO World have doubled to their highest level since the near-400p high reached immediately after their flotation in February last year.

Panmure acknowledged that the FTSE 250 company is a "high quality e-commerce business" but that the UK retail market for major domestic appliances (MDAs) is a "notoriously difficult" market to operate in due to limited brand loyalty, fierce competition and elastic demand together all stifling the industry’s profitability.

Along with concern about the reliance on product protection plans, Panmure analyst Michael Stewart forecast that AO will reach a peak of margin progression by 2017 and its limited potential for operating profit imposes a severe ceiling on the company's potential intrinsic value.

"We calculate that 78% of total future margin progression will be realised by financial year 2017 with limited margin progression thereafter.

"A diminishing rate of growth and a deteriorating gross margin will depresses the degree of operating leverage and cause a peak in profitability just nine years from now.

This means, if his analysis is correct, that AO’s core UK business "is unlikely to ever generate more than £64m of adjusted operated profit", which equates to post-tax earnings of 12p per share.

"If we assume that a fair valuation multiple for this stock to trade in a stable state of growth is 10 times, then the implication of this analysis is that AO’s core UK business will never realise an intrinsic worth in excess of 120p."

Stewart's cashflow analysis calculates that AO’s core UK business is worth roughly £530m, or 127p per share.

Although a simple linear regression analysis shows AO World is trading at an "equitable price given its expected rate of future growth", the analyst argued that "investors should be receiving a higher unit of sales growth per unit of price than the prevailing market price implies".