Iceland - Estimating Cashflow Reversals
All,
It’s been a bit of a ride of course and after increasing our position in March in the low 70s, we feel the name has overshot on the upside. We are therefore unwinding our long position in Iceland 25’s on concerns that the projected 4.5x Q1 leverage is flattered by a substantial Working Capital inflow, which should reverse over the remainder of the Financial Year. We calculate underlying leverage to be 5.1x (see calculation below).
Iceland’s guidance for less than 4.5x leverage at end of Q1, post transaction, is based on Covid-19 related expenditure treated as exceptionals plus one quarter of the (12 month) rates holiday. The Company has guided that the Covid-19 expenditure should be c. £-30m for FY21, with the rates holiday of £40m more than offsetting these costs over the year.
Trying to piece the numbers together we have the following assumptions:
As reported FY20 EBITDA was £134m, with cash of £140m and Net Debt of £687m (Gross Debt £827m) 5.1x.
In Q1FY21, the Gross Debt decreased by c.£20m (£40m FRN repayment less £20m New 14 month facility, assuming lease debt static). Gross Debt £807m.
Cash has reportedly decreased by £20m to £120m, leaving net debt of at the same level, £687m
To achieve leverage of 4.5x, LTM EBITDA must have increased to c.£153m, a £19m increase for Q1FY21 over reported Q1FY20.
A simplified cashflow for Q1 would look as follows:
EBITDA £40m
Rates (exceptional) £10m
Covid-19 (exceptional) (£30m) * has accrued, either spent or increased WC
Working Capital £70m
CAPEX (£10m)
Interest (£20m)
Change in Debt (£20m)
Dividend (Brait) (£60m)
Change in Cash (£20m) (As given by the Company)
Cashflow reversal:
Based on 10-12% increase in sales, Working Capital would normally see an inflow of c. £25-30m. Additionally working capital might have increased due to timing in relation to the Covid-19 exceptional expenditure. But either way those positions would reverse assuming a return to “normal” trading. Additionally, the postponement of the opening of the ambient depot has postponed the related inventory expenditure to a later date this year, accounting for an additional £10m outflow to come. These outflows will be offset by £30m “inflow” of the remaining 9 months of rates that no longer have to be paid. Therefore, net reduction in cash over the year, ignoring earnings, would be unto £-50m, adding back ~0.35x leverage from cashflow reversals.
Underlying Leverage:
Assuming the Company can keep £10m of the Working Capital gains, the underlying Cash position at Q1 would be £40m lower, at £80m. Additionally, we treat the remaining Brait payments (£55m) as Senior Debt, since the payment will have to be made before bond maturity and is covered under baskets. Therefore, Gross Debt would equal £807m + £55m = £862m, with Cash (£120m-£40m) = £80m. Net Debt of £782m, which based on LTM EBITDA of £153m equates to leverage of above stated 5.1x.
The Company has leveraged up (gross) with the recent transaction. From the 5.1x we calculate, we expect the Company to deleverage from OCF over the remaining 3 quarters. However, by our projections year-end leverage is unlikely to reach management’s 4.5x and thus in reporting terms the company should re-leverage over the remainder of the year to a figure between the two multiples.
Iceland have held a Q&A call yesterday afternoon after their online presentation was released in the morning. But we still await full details of the movement in Working Capital, in order to reconcile the cash balances disclosed on the presentation/call. Company are due to publish Annual Report on the 6th July, with Q1FY21 due on 30th July.
Happy to discuss further.
Tomas