Key points:
- Atradius has cut credit insurance cover for AO World
- This could be just a trivial change in terms and conditions
- But credit insurance is vital to a retailer – this could be serious
Over the weekend the news came out that credit insurance for AO World (LON: AO.) has been cut. This is one of those things that can be just a temporary hiccup in a corporate progress, it can also be the start of a death spiral. It's worth thinking about which this might be.
As we know AO World is the retailer of white goods online. The company has been startlingly successful and was hugely boosted by lockdowns when most rival physical store retailers were shut. However, since reopening AO World shares have done badly, falling from 240 pence to closing Friday at 68 pence.
The specific event here is that the credit insurer has cut cover for those supplying AO World. This might seem a small issue and at times it can be. Unfortunately, at others it can be the start of a death spiral for a retailer. The secret being that the actually stocking up part of a fast turnover retailer is a capital negative operation. If that credit cover gets cut substantially then the requirement for ever more capital can eat the company.
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The report, from the Sunday Times, is that Atradius has slashed cover for suppliers to AO World. Atradius is a credit insurer and it's worth understanding this part of the retail business. Any retail outlet hopes to sell many times before it has to pay. The credit terms might be – just as an example – 120 days, but they might turn over the stock every 30 days. So, they sell four sets of stock before they pay for the first one. Suppliers are only happy to do this if they are certain they will get paid – credit insurance.
The business effect of this is that stock turnover in a retail business is a capital negative activity. They don't need capital to have stock, quite the opposite, they get to keep the sales money for 90 days before they give it to the supplier. This is great, of course. Except when – or if – this goes into reverse. If the credit insurer won't guarantee the payments to the suppliers then they will be demanding cash on delivery. Which means that stocking the retailer goes from being a capital negative activity to one that swallows vast amounts of necessary working capital. And, of course, this has to be found at a time when people are nervous about finances – otherwise why would the credit insurer have cut cover?
It really is possible for a retailer to be eaten from the inside by this seemingly trivial occurrence. Credit insurance gets cut, suddenly a retailer faces a business ending demand for vastly more working capital.
Now, whether this is actually happening to AO World is another matter. This could be just some small change in conditions or credit lines. But given the risks it's likely that there will be a certain hesitantcy about AO World shares until this is all resolved and or clearer. For the market really does know that this can be the beginning of the slide.
