Elior - Beyond DMS
All,
Please find our initiation on Elior here.
Quantum and timing of Elior's EBITDA recovery remain highly uncertain. And while the pending DMS contribution will be moderately deleveraging, we still see value cushion under the bonds of below 35% on a PF basis, and covenants would still get tight under our base case from H2 2023.
Elior's LTM EBITDA at Sep-2022 stands at below €40m compared to its pre-covid 2019 EBITDA of c.€300m, which the bond was effectively marketed off in July 2021 (at which time reported LTM EBITDA was in negative territory). This depressed EBITDA level results from inflation in its cost base, particularly within food and labour costs, with most of its contracts not providing for full real-time cost inflation pass-through, requiring Elior to negotiate pricing revisions with its customers. Additionally, volumes have still not fully recovered to pre-pandemic levels, at least partly owing to higher remote working rates impacting its Business & Industry division.
Investment Considerations:
We will be exploring a short position in the SUNs following the Elior shareholder vote scheduled for April 18th which is to approve the stock-funded (deleveraging) acquisition of DMS by Elior. The bonds are trading inside 9% on the forthcoming acquisition of DMS, and expectations of a recovery in EBITDA.
While the DMS acquisition is likely to complete in our view and will be deleveraging, Elior's EBITDA recovery largely depends on its ability to negotiate price increases with its clients given inadequate provisions for inflation pass-through in most of its contracts; this is something of a wildcard (particularly in the case of public sector contracts where Elior's negotiating position is often limited by the termination costs it must pay on early exit from the contract). We expect covenants to get tight post H1 2023 (on a PF basis, excluding targeted synergies), and with significant cash-burn at least through FY2023 under our base case, Elior will likely be dependent on drawings on its RCF and/or securitization facility for liquidity.
The biggest risk to a short would be a subsequent equity raise or even acquisition of control by Derichebourg Group (with the latter triggering a CoC put), and stronger than expected cost inflation pass-through. However, if the former does materialise, we don't think it will be immediately following the contribution of DMS and therefore see potential for the bonds to trade materially lower post H1 and H2 2023 results.
Cost inflation pass-through:
Elior is experiencing significant rises in its cost base, particularly within food and labour costs, and the majority of its contracts do not allow for real-time full cost inflation pass-through.
While Elior's P&L private contracts (c.55% of sales) appear to allow for some formula-based pricing revisions, the price rises Elior needs to offset this level of inflation generally require negotiation.
Elior's P&L public contracts (>30% of sales) are most problematic, with index-based pricing revisions only annually, and often the formula doesn't adequately represent the extent of Elior's cost inflation; furthermore, Elior is often prevented from exiting the contract early without significant penalties, thereby substantially weaking Elior's bargaining position in renegotiating public-sector contracts.
Elior continues to work through price negotiations (which are taking longer than previously expected) and only c.40% of run-rate negotiated price increases are baked into fiscal year 2022 results. Also these negotiations are not yet complete (as of Dec-2022, c.73% of contracts by number identified as requiring renegotiation - for example excluding cost-plus contracts - have been renegotiated according to Elior, compared to a 90% target by year-end). However, the full LTM run-rate cost increase also isn't 100% reflected in Elior's LTM reported financials. Inflation remains elevated (and it isn't clear how or whether the new negotiated terms account for future inflation) and it is likely Elior will end up absorbing at least a portion of these cost increases in the longer-term given a lack of pricing power generally, in our view.
Post-covid catch up:
Business & Industry accounts for c.40% of group revenue with white collar sites (most affected by remote working trends) accounting for c.40% of 2019 Business & Industry revenue. The post-covid volume 'catch-up' appears to be approaching a limit; Q1 2023 group revenue (constant FX) was at 94% of 2019 levels, following c.95% in Q4 2022, which the company has described as a "new normal" due to higher remote working rates. And these levels would appear to include the effects of price increases, implying an even lower LfL volume run-rate vs. 2019 levels.
DMS contribution:
The acquisition amounts to a moderately deleveraging asset contribution but isn’t enough to offset the loss of EBITDA from cost-inflation absorption and structurally lower volumes within Business & Industry, under our base case.
Under the announced terms, the acquisition of DMS by Elior from Derichebourg Group would be funded with c.80m new Elior shares, with the asset travelling debt-free and adding c.€50m in EBITDA to Elior on a post IFRS 16 basis (before targeted run-rate synergies of €30m). The transaction would result in Derichebourg increasing its stake in Elior to c.48% (from c.24% currently). Expected completion date is 18-April 2023 (the same day as the planned Elior shareholder vote). While we do see a reasonably high chance of completion, it should be noted that the documentation is not yet publicly available for us to scrutinise. Overall, after including DMS, we see an equity cushion of c.35% under the bonds.
Capital structure risks
While the DMS acquisition is likely to complete in our view and will be moderately deleveraging, we expect covenants to get tight post H1 2023 (on a PF basis, excluding targeted synergies), and with significant cash-burn at least through FY2023 under our base case, Elior will likely be dependent on drawings on its RCF and/or securitization facility for liquidity.
Edward
E: elewisohn@sarria.co.uk
T: +44 203 192 0200