Cerba - Q1 Results - Testing our Patience.
Dear All,
Please find our updated model post the Q1 2024 results, here.
Since our initiation and short position in both the 2029 and 2028 notes, the only material change in the story is the announcement of the sale of the vet business (which is a market leader in France) to US veterinary services giant - Mars for more than 20x EBITDA of €2 million. This caused the bonds especially the 2029 notes to rally. However, the rest of the fundamental story remains the same.
Post the Q1 2024 results, Cerba is still struggling to win contracts in the Research division, it still needs to negotiate tariff cuts with Italian healthcare authorities and needs to maintain capex at 4.5% of revenues to update IT systems in the Research Division. While management is implementing synergies and cost cuts in 2024 and 2025 and the sale of a vet business for €40 - €50 million will help it to temporarily de-lever, that is getting offset by a higher cash tax outflow and EBITDA margins will remain below its target of 25% until 2025 with net leverage remaining elevated at approx. 11x.
Investment Rationale
We are maintaining our short exposure in Cerba in the 2028 Senior Secured Notes and the 2029 Senior Notes
2029 Notes: Given the lukewarm Q1 2024 results, we are maintaining our short position at 3% of NAV as we see a gradual improvement in testing volumes which is the main deleveraging catalyst along with no growth in the research division in the coming quarters in 2024. We feel that the notes could fall to 50s as market participants see this as a recovery rather than a yield play and expect a slow recovery in results to continue.
2028 Notes: We are also maintaining a short position with a target price of 70 (yield of 14%) at 3% of NAV due to the same reasons as above. The bonds are vulnerable to a ratings downgrade (currently at B-) and the company admitted on the Q1 2024 call on no new update on an agreement with the rating agencies. Given the high probability of a ratings downgrade, we expect more sellers adding to a weak fundamental story with elevated execution risk.
Current Trading - clear as mud
- Q1 2024 revenues at €503 million declined by €30 million (-5.5%) due to a decrease in COVID-19 testing revenues which is a continuation of the past couple of quarters. Testing volumes in France increased by 8% in Q1 2024 which was higher than what we were expecting. However, the company continues to guide to low single-digit volume growth for the rest of the year which implies a slowdown.
- The other sources of under-performance / rationale for our positioning include:
EBITDA under pressure from the dilutive impact of recent acquisitions and negative operating leverage with EBITDA margins expected to be below its 25% margin target. The company expects to reach that level only in 2025.
No visibility on growth or new contracts in the research division and no growth in the backlog.
Higher than expected cash outflow from taxes with guidance of €90 million for 2024.
High fixed costs with personnel expenses remaining at 42% of revenue
While management pledged to no M&A going forward – growth & maintenance capex remained elevated at 4.5% of revenues
- While liquidity remains strong at €261 million, free cash flow remains non-existent in 2024 due to the above.
- The sale of the vet business will be used to paydown the RCF, that will be offset by the higher cash outflow from taxes, hence we see no improvement in leverage.
Housekeeping
The next catalyst on this name will be the full reporting of the Q2 2024 financial results which may prompt a reaction to the trading levels of the bonds and our views. The proverbial elephant in the room that investors would like clarity on are when do we see an acceleration in testing volumes across its main markets in France & Italy as well as wins in its research division and how that would flow to its financials and help it de-lever? Cost cutting and non-core asset sales can move the needle only so much
Saahil
T: +44 203 192 0200
www.sarria.co.uk