Investors’ Chronicle: Kitwave, Currys, AO World

BUY: Kitwave (KITW)

The company expects full-year results to come in ahead of market expectations, writes Christopher Akers.

Kitwave shares have more than doubled since they floated on the Alternative Investment Market (Aim) in May 2021, with the Tyne and Wear-based food and drink wholesaler impressing investors with strong revenue growth, gross margins which have headed northwards, and the building up of its position in the UK market through acquisitions.

The company, which also supplies tobacco and chewing gum, sells to independent customers across the UK from 29 depots and has a client base of about 42,000. Revenue growth in the half was driven by higher prices and acquisitions. Retail and wholesale revenues were up 15 per cent to £194mn, while food service sales climbed by 49 per cent to £81mn. 

Gross margin rose by 180 basis points against last year to 21.6 per cent, no mean feat in this inflationary environment. While there are headwinds from labour and delivery-based costs, management’s focus on margin development is paying off and cost control is evident. 

The £28mn acquisition of Westcountry Food in December supplemented the purchase of MJ Baker last February, and expands the company’s presence in the South West. A new 80,000 square foot distribution centre is being constructed, which will help “supercharge the organic growth opportunity” in the area, chief operating officer Ben Maxted told Investors’ Chronicle.

Debt has risen because of the Westcountry acquisition, with leverage up to 1.9 times and finance costs also climbing. But fears are soothed by strong cash generation here, albeit the £11.7mn posting in the half was down from the £17.1mn last year.

House broker Canaccord Genuity upgraded its forecasts for the seventh time since IPO in the wake of these results, and now has an increased target price of 435p. With an attractive forward earnings valuation, robust recent trading, and a guidance uplift from management, we initiate on the bullish end of things.

HOLD: Currys (CURY)

The company missed its debt targets as trading deteriorated, writes Christopher Akers.

Problems in the Nordic business seem to have become a painful thorn in Currys side, rather than a short-term hiccup. The electrical goods retailer’s shares were marked down by 13 per cent after it cut its final dividend on the back of Scandinavian trading troubles and missed debt targets.

Chief executive Alex Baldock said Nordic progress “was brought to an abrupt halt”, revenues fell by 7 per cent and cash profits plunged by 82 per cent there. Earlier this year the company warned of heavy competition from other white goods retailers selling off stock that would have gone to Russia if not for the invasion of Ukraine. 

The top line was impacted by consumer spending and inflation headwinds across the board, with the only growth coming from the company’s small Greece division, where sales were helped by government subsidy programmes. The Scandinavian performance overshadowed a 45 per cent uplift in cash profits in the domestic market of the UK and Ireland as progress was made with operating cost savings, but revenues still fell by 8 per cent.

Management’s position of being “wary of optimism about consumer spending power” in the months ahead was not received well by investors, not surprising after the revenue contraction.

One result of softer demand and weaker trading was that Currys missed the debt targets it set out last November. It aims to keep net indebtedness leverage below 2.5 times and total indebtedness fixed charged cover above 1.5 times, but at the year-end these came in at 2.91 times and 1.42 times respectively. This was a key reason for the dividend cut.

The chunky loss before tax was driven by £511mn of non-cash impairment of goodwill from the 2014 Dixons Carphone merger because of higher UK bond yields. Currys is stuck with Dixons’ pension obligations, and company guidance is for pension contributions to come in at almost £330mn over the next five years. This is cash that could have been put to more productive use.

Analysts at Investec argued that if consumer spending and inflation problems ease, Currys profits could offer significant upside, “especially if a new technology replacement cycle starts to re-emerge”.

If the Nordics headwinds can be overcome, the future will certainly look brighter, though the challenging environment means that capital expenditure is set to be cut by around a quarter this year to £80mn. Frasers now has a 10.4 stake in the business, so a potential collaboration could open up some interesting avenues.

HOLD: AO World (AO.)

The retailer has refreshed its business model through cost efficiencies and streamlining, writes Christopher Akers.

Online electricals retailer AO World returned to profit, despite revenues falling by almost a fifth. The company reported in line with pre-close guidance after implementing a strategic shift as it tries to drive much-needed profit and cash generation.

AO World exited business lines, stopped trading in Germany, ended its trial with Tesco and contracts with housebuilders, implemented “significant” lay-offs focused on senior and middle management roles, and introduced delivery charges for all orders. Cost-cutting helped its gross margin, which was up by 160 basis points to 20.9 per cent, as the cost of sales fell by £205mn.

One result of the change in direction was the big contraction in revenues, however. Product revenues, which contribute three-quarters of the company’s sales, were down by 22 per cent to £875mn. But this wasn’t just due to strategic changes and action on profitability — the company also flagged that “the impacts of the cost of living crisis on consumer spending” hit performance in its key division. Top-line growth was posted in the smaller services and third-party logistics divisions, but commission and recycling sales also fell.

Elsewhere, the company said that the annualisation of savings should offset inflationary pressures and help it to keep its administrative cost base of £226mn flat in 2024.

AO World entered a “strategic partnership” in June with Mike Ashley’s Frasers, which has built a 22 per cent stake in the business, and is now its biggest shareholder. The retail tycoon won’t be pleased to see that the market wasn’t blown away by these results, based on the flat share price, but strategic progress was made. 

Despite that, there were no guidance updates. Management is trailing a 5 per cent cash profit target in the short term and revenue growth in the medium term.

Broker Shore Capital said that minnow Marks Electricals “offers better value” in the same retail space, with a free cash flow yield of 6.1 per cent and an 11 per cent FCF compound annual growth rate for 2024. That company is one to watch, but despite better opportunities elsewhere, there is also life in AO World yet, with Ashley’s manoeuvres something to keep an eye on. House broker Numis forecasts cash generation of £30mn-£40mn in each of the next three years and a less demanding price/earnings ratio of 16 times for 2025.