AO World PLC (LSE:AO.) saw its share price tumble 18% as the markets opened on Monday, down from 67.8p to 58.1p, and fell a further 12% today, after a report from The Sunday Times suggested it had its credit insurance cut by its provider.
A statement from the company aimed to reassure investors that its financial performance and position remained in line with management expectations, but it provided scant relief for AO’s falling share price.
AO World wasn’t the only specialist retailers to see its share prices take a tumble today.
Pets at Home Group PLC (LSE:PETS) fell 11% to 274p on yesterday while Dunelm Group PLC (LSE:DNLM) fared slightly better, down 1.5% to 817p.
Now, there’s no shortage of sources for pessimism in the retail sector at the moment – and, separate broker downgrades, each by Royal Bank of Canada (TSX:RY), was a factor in Pets and Dunelm going lower – nonetheless the weekend reports of tightening credit insurance spells bad news for a sector already grappling amidst the cost-of-living crisis.
What is a credit insurer?
AO’s credit insurer, Atradius, cut its cover after a drop in the company’s finances.
But, what does that actually mean?
Credit insurance exists to protect suppliers from buyers. It is basically a guarantee that helps streamline supply chains.
Without credit insurance cover, suppliers usually require payment upfront rather than providing a line of credit.
So, it is then, that white-goods retailer AO finds itself in a tough spot.
It compounds a challenging period that in April saw the company issue its third profit warning in three months.
Why the insurance is so important?
Essentially, credit insurers allow retailers to hold stock from their key suppliers.
They “really grease the wheels to make supply chains work and payments smooth,” according to Neil Wilson, an analyst at markets.com.
“Suppliers can deliver and then wait for payment which is a good system for retailers so they don’t need to pay upfront for everything.”
When the system works, it works really well, added Julie Palmer, a partner at corporate restructuring firm Begbies Traynor (AIM:BEG).
However, as Palmer explains. “when the relationship breaks down, it can break down quite spectacularly.”
The collapse of Toys R Us, in 2017, is one specific example from the fairly recent past.
Palmer highlighted: “the market got really nervous about whether it [Toys R Us] was on the precipice of failing for the credit lines very quickly.”
What does that spell for the rest of the industry?
It’s understandable then that the weekend reports sent jitters across the entire retail sector.
Palmer argues that, for some, it is getting to a stage where the insurance premiums may become far too large.
To make matters worse, the cost-of-living crisis is eroding the retail sector.
It is a particular threat for many product lines carried by the likes of AO, Pets At Home and Dunelm, which many consumers tend to treat as ‘discretionary’.
“I think retail of any kind is in trouble since discretionary spending is going to get whacked by inflation and terrible consumer confidence,” said Wilson.
“Household appliance spending is at its worst level in eight years, people are cutting back on all but essentials so pets, soft furnishing, white goods are all going to come under pressure.”
AO are the first of the retailers to have their insurance cut amid the cost-of-living crisis, but they may not be the last.
As spending habits change, the risk that businesses can no longer keep up with payments rises further still, in turn, ratcheting premiums up higher still.
It’s a vicious cycle that, if it gets that far, could see whole business models stall.
Investors in retail will be watching on, nervously.