Selecta - This time it could be different

All,

Please find our re-initiation of Selecta here.

We are not taking a position. Ever since we dissected the name in 2017, we have been immensely sceptical about it - punctuated by a brief technical period following the 2020 restructuring. The reason has been the same from the start: World Domination is hard to come by. Under KKR the company has tripled its fleet in a quest for pure size and in the hope that if it could only acquire enough sites, it would sufficiently densen its route network to squeeze out a little cash flow. Clearly, that did not work. But following the Pandemic, management’s hand was forced to change tack and shrink the fleet and so with this different strategy, this time it could be different. The problem is that we think it won’t be different enough.

Investment Considerations:

- We won’t be taking a position, because we think that even if Selecta performs reasonably well in 2023 (by its own low standards), the overall capital structure remains well under water and should hold back exactly how tight the SSNs will be moving for instance or how much imagination we are willing to price into the 2LNs. 

- However, a more flow-oriented investor might find that if the odds are that Selecta will look better in a year than it does now and if consumer cyclicals are making a come-back, then the yieldy instruments should perform well in relative terms and KKR have until 2026 to find a solution anyway. 

- Both could be right, but on balance we find there are cleaner names in which to earn 15% for senior exposure and there are 2LNs to be bought in the 50s that are further in the money than Selecta’s. Also, any reliance on KKR seems difficult to us while we see quotes for the Prefs around 15 c/€. We are concerned that the name will fall by the wayside a little bit as investors concentrate on stories with less fur.

Why the sudden performance:

- Cashflow is not something we are used to seeing from the vending giant. So it is hard to argue that its fortunes should be turning around. However, vending is very much an 80/20 kind of business, where 20% of your machines generate 80% of sales. So when demand drops as it has after the pandemic, there is plenty of scope to cut unprofitable machines and that is what Selecta have been doing. As a result, the revenue per machine is rising and - to simplify a little bit - that is the closest proxy for increasing profitability. 

- While we have clearly witnessed an improvement in profitability, however, we have yet to see the real impact from route optimisation on the back of it (may not be coming). The limit of cutting per se unprofitable machines is that only because you have dropped a machine from service etc, you may not be able to practically reduce your merchandising and maintenance staff/vans by a linear amount. So this exercise requires really heavy lifting - some of which is reflected in the high and permanent one-off costs Selecta are incurring. 

Certainty:

- The only way modelling Selecta makes any sense to us is to project the fleet and then to declinate that down into a P&L and CF. 

- For a numerically driven fleet operator like Selecta, the company is releasing precious little data to investors. So just like last time we have had to make a myriad of assumptions around GM and overheads and CapEx by machine type etc. as well as how linear the relationship will be between the number of machines in service and their corresponding overheads.

- Minor changes to our assumptions therefore can have quite pronounced effects on the forecast period, but we have back-tested as far as possible and are ultimately comfortable to suggest that the current improving trend should last through 2023.

Will it last?

- KKR can make it last, but that would mean diverting significant cashflow to debt service as opposed to growth and without the latter, where is the exit for KKR? So it may last for as long as KKR see a chance of refinancing the bonds somehow. 

- The current FCF is based on a temporarily low CapEx profile where discontinued machines can be used to replace existing or new machines with no up-front purchase required for Selecta. However, this strategy has a half-life when competitors start introducing newer models and eventually CapEx has to normalise or be replaced with leasing agreements which should drop the P&L. There is no free lunch - and certainly not in vending machines.

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk