Cerba - Testing for a Turnaround
Dear All,
Please find our updated analysis post the Q3 2024 results on Cerba here.
The organic growth continued (post-COVID normalisation) for the routine & specialty testing business. The forward looking KPIs for the Research Division (backlog, contract wins & book to bill ratios) continue to improve with the division returning to organic growth in Q4 2024. Given the challenging regulatory backdrop, Cerba is being managed for cash (no M&A going forward, cost cuts and maintenance capex). The business burned a little cash but liquidity remains robust. Management also mentioned non-core asset sales on the earnings call in the medium term.
While baby steps in the right direction, Cerba is still significantly overleveraged (on a reported EBITDA basis) with the sponsor “out of the money” - they have three options to accelerate cash generation (through a combination of top line growth & cost cuts), split up the business and sell non-core assets or inject vast additional equity to facilitate an A&E in 2027. If none of these come to fruition - then the business will need to restructure. Therefore the next couple of quarters in 2025 is going to be key as to how this situation will play out.
Investment Rationale:
- We are neither taking a position in the SSNs nor in the SUNs as we do not yet have sufficient evidence that Cerba can turn the corner fast enough to raise its debt capacity by 2027/28 beyond 67c/€ on the SSNs. We therefore also don’t think that a 20% YTM on the SUNs is the right way to value these bonds and would only begin to consider these some 20 points lower.
- Post the Q3 2024 results, we are encouraged by the progress made by the company in managing through the downturn however we are waiting for more evidence on growth before we get more constructive on the capital structure.
- What will make the Cerba bonds work: 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 senior secured notes do not yield enough to make this interesting while economically the senior notes should be viewed an out-of-the-money equity warrant. If the trend in the recovery continues, the SUNs might get interesting as they has the maximum upside.
- It is too soon to position ourselves for a hard restructuring scenario as the company has adequate liquidity and operational levers to operate on a free cash flow breakeven basis.
-We feel that Cerba is a good business with a solid market position. However, it has been negatively affected by tariff cuts in France which affects 50% + of its business and market concerns around its high leverage.
-Our projections show only a slight acceleration H2 2026 however as we get more evidence of a more sustainable trend – we will refine our projections for 2026 and 2027.
Second quarter of turnaround:
-Return to organic growth: Q3 2024 revenues of €439 million included 2% growth in the French routine testing segment (its second in 2024). In addition, growth in its specialty and other segments of the routine testing segments also showed low to mid-single-digit growth.
-The management also stated that demand for testing continued to grow despite decline in prices for tests.
-Q3 2024 EBITDA above Sarria projections: The company reported EBITDAR of €134 million which was higher than our projections of €98 million with EBITDAR margins of 30% +.
-Research division - leading indicators point to recovery: Q3 2024 revenues at €48 million which declined by 7% however the division won a US$ 120 million contract which is expected to flow through the financials in Q4 2024. In addition, the backlog increased to €393 million from the previous quarter at €380 million. The book-to-bill ratio also exceeded 1x.
-More non-core asset sales: The company mentioned more non-core asset sales in the medium term (e.g. the testing, inspection & certification segment).
-Management expects the business to be run on a maintenance capex basis in the medium term. Sarria has projected maintenance capex to be 3% of revenues for 2025 and 2026.
-Cash burn was a minimum €7 million and helped by the sale of the European vet business to Mars for €82 million with liquidity remaining strong at €189 million (and higher than €157 million in Q2 2024).
Evidence of further recovery will be driven by accelerated growth in demand for more tests & research contracts:
-We are assuming low single digit revenue growth in 2025 with an improvement to 4% growth in 2026.
-What would drive upside to our projections: Better like-for-like comparisons in 2025 and 2026 for the routine testing segment, accelerated growth in the specialty business and new contract wins in the Research division.
-EBITDA and cash generation to be helped with cost discipline, synergies of €79 million over the next two years.
- Assuming reported EBITDAR of €450 million to €500 million+, the business is being run on a free cash flow break-even basis (based on our projections of cash taxes, working capital, capex, cash interest and lease costs)
-Sponsor is well out of the money, but support is still a possibility: While depending on performance in 2027, we note that EQT has a track record of supporting its investments (e.g its €500 million equity injection in WS Audiology to facilitate a refinancing in Q1 2024) in an A&E scenario if a par refinancing is not feasible by then.
We look forward to following what could be an interesting turnaround story in the healthcare sector.
Happy to discuss,
Saahil
T: +44 203 192 0200
www.sarria.co.uk