Cerba - Light at the end of the tunnel? - Positioning
Dear All,
Please find our updated analysis post Q2 2024 results here.
We are changing our outlook on Cerba from a negative to a positive stance as we see signs of a turnaround. While we might be early on the inflection point in fundamentals, we think now is the time to sharpen our pencils.
Investment Rationale:
- We are unwinding our short position in the 2028 and 2029 notes as the company shows glimmers of a recovery which may lead to accelerating growth and no further deterioration in its business (as per Q2 2024). We are warming up to the senior notes due 2029 but we want to see another quarter of growth before we jump in completely as the improvement might be slow and lumpy and the senior notes sit behind nearly €4 billion of senior secured debt and hence represent “preferred” equity type risk.
- Post the Q2 2024 results, Cerba has started to show organic growth in its core Lab business as like-for-like comparables improve going forward. Management has also shown discipline in costs and capex. The key unknown is the Research division which has yet to grow revenues as it wins business and will only have a positive impact on financials in Q4 2024 as well as the impact of tariff cuts in France and Italy. Net leverage will remain elevated in 2024 and will only improve in 2025 & 2026 as revenues accelerate and the impact of operating leverage is felt through its financials.
- 2029 Notes: Given the improving Q2 2024 results, the senior notes stand to benefit from accelerating growth in the core lab business, a recovery in the Research Division and synergies from cost cuts in 2025 & 2026. Management is also not planning any large scale M&A projects and is keeping capex at close to maintenance levels. The pricing and return profile in the mid-teens are attractive as it is priced like mezzanine or preferred equity albeit in a large cap business which has a reason to exist. In the meantime, the notes continue to decline in the secondary market on negative news headlines around tariff cuts and lab strikes which is creating an interesting entry point.
Q2 2024 results:
-Q2 revenues were €480 million with the core French medical lab business (54% of
revenues) showing positive growth at 3% (its first positive growth since the December 2022 quarter) as like-for-like comparables get better. This should be an improving trend going forward.
-Tariff cuts in France that were implemented are being offset by cost containment measures which is reflected in the Q2 2024 Reported EBITDAR of €93 million which showed an improvement in the margins by 300 bps at 19%.
-Q2 specialised lab revenues also showed strong progress with revenue growth at 8%. At 16% of revenues, they will continue to offset any weakness in the core medical lab business.
-Operating capex is being controlled at €21 million (4.3% of revenues) vs. 6.8% in 2023 which demonstrates that the business is being run on a recurring & maintenance capex basis. Other than earnouts, all M&A is on hold for the moment.
-Liquidity is strong at €163 million as per the end of Q2 2024 which is expected to improve in Q3 2024 with the proceeds of the €83 million sale of the vet business. The proceeds will be used to pay down RCF drawings.
Outlook:
-The results in the Research Division for Q2 2024 remain weak with revenues declining at -10% however there is a six-month time lag between when a contract is signed and when it gets recognised on the financials. Management has stated that revenues will grow in the Q4 2024 and we have modelled improving growth going forward.
-Q2 2024 backlog remained static at €380 million. While difficult to model going forward, we expect the backlog to grow as R&D budgets from pharma clients continue to recover. This would be a leading indicator of growth in the Research division and be an important source of growth for the company going forward.
Therefore we think the right combination of positive growth in the core labs business, winning contracts in the research division, cost cuts & capex containment going into 2025 will be key to price appreciation of the Cerba SUNs as the business starts to delever again
However, the path to investment glory will be volatile and lumpy as the turnaround will be gradual and could take up to two years.
Happy to discuss.
Saahil
T: +44 203 192 0200
www.sarria.co.uk