Selecta - Called the Shot
All,
Please find our updated analysis on Selecta here.
Last month we felt very bullish about Selecta and its prospects for the year. We thought we’d model audaciously. A month and one reporting later and we have lifted our projections again. In particular, we think the improvement will be front-loaded and drive the market’s fantasy in the Prefs. The primary drivers for the improvement are the cost savings the company seems to be able to hold on to, the Paris Olympics and of late: double-digit sales price rises at only marginal volume loss.
Investment Rationale:
- We are holding 2% and 4% of NAV in the 2LNs and the Prefs respectively on the thesis that the company will boom this year with Paris Olympics to come and following the end of its turnaround plan.
- On our math, the Prefs now trade at approx. 5x our 2024 EBITDA projection - if we assume KKR were ready to subordinate their piece in return for a refinancing. We think that is very reasonable.
- Recap: Ahead of results last month we sold our position in the SSNs @ 98.125c/€, worth 4.2% of NAV. We bought these back in March last year and they have done well. We have kept our 2% of NAV position in the 2LNs for now, yielding just shy of 15% to maturity. We have added another 2.7% of NAV to our existing 1.3% of NAV position in the Prefs at 52c/€. Liquidity wasn’t super fantastic, so we’ve had to pay up a bit. Our total position size has therefore reduced from 7.6% to 6%, but the risk weighting is now significantly increased. We will also be earning more PIK than cash and there will be less pull-to-par into maturity. Non-payment of the Prefs does not constitute default but rather triggers an automatic conversion into equity (need 30% of SSN Prefs to request) where the KKR portion receives economic but non-voting common shares.
- As a caveat, we understand that recently the Swiss CEO has departed and wonder if that stands somehow in connection with the renegotiated SBB contract. We have naturally not had details on the economic details of that negotiation, but imagine that any ramifications could be important.
Q423:
- Operationally Q4 was a strong quarter - as signalled, coming in with €17m less revenue, but €12m more EBITDA than we had modelled. The company has begun to raise prices quite strongly and at the expense of volumes. That has been hurting top line, but to the benefit of earnings as the higher prices feed through directly.
- As regards cashflow, all of that P&L improvement was given up in a vast outlay of "One-Offs" - approx. at the level of the Q422 nadir - of which another €4m are hanging over into 2024. However, the big news is that Selecta have announced the end of their machine reduction and turnaround plan and that going forward the One-Offs are to come to an end (see Company section). Guidance was not precise on this point, so we are modelling a gradual reduction over the year and are keeping some outflow - just in case.
- Management recognised that Gross Margin is still low, compared to historical levels, but did not specify any time frame in which it would return, emphasising that it won't come back in one go.
- CapEx was guided to remain in the 4-5% range, which should support growth, so long as clients remain willing to lease their equipment, which for now seems to be true.
- Considering the better-than-modelled development and reconsidering certain sandbags and seasonal profiling, we have raised our expectations for 2024 very slightly.
Telemetry:
- Expenses continue at their lower level. Personnel and Other Operating expenses remain down YoY and ostensibly by more than any reduced sales might imply. Incidentally, this was in part offset by lower Other Operating Income, which is usually high in Q4, but not this time. We expect such Other Operating Income to remain low and stable from here.
- We see therefore the company holding on to the cost savings it has created with telemetry.
One-Offs:
- The company has declared an end to its cost-cutting plans and pronounced the fleet and associated expenses stable from here.
- Along with that went the assurance that One-Offs would also dissipate, although we did not get a precise time frame. According to management, only €4m of such expenses is hanging over into 2024. We are modelling a more gradual reduction, but there is a chance that the one-offs drop immediately (remote chance by the history of it, but the program has never been declared over). We could imagine that KKR were keen to squeeze the tail of the machine reduction plan into FY23 - hence the large "final" One-Off outflow in Q423, so as to present as strong a set of financials in the coming year and sell the business thereafter.
- That the One-Offs are therefore a thing of the past is not our base case, but it is plausible and we are positioned for it.
Exit:
- KKR are reportedly looking for an exit. We think that should be another year away, during which the company can show strong organic growth. We will hear the Olympics story talked down of course.
- We understand that KKR have recently contacted a number of potential investors - including former owner Compass, Lavazza and Costa (Coca-Cola) - but that no sales process has officially taken place. We find the timing odd and think it might more likely have been some sort of "calling the shot" where they'll have said - look this is going to go great - you'll see. We'll be looking to sell it in time - whenever you're ready...
Looking forward to discussing this name with you.
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk