Cerba - Testing the market - Positioning
Dear All,
Please find our initiation on Cerba here.
Cerba needs to diversify away from the commoditised routine lab test division to other divisions that are less vulnerable to volatility and cuts in tariffs imposed by governments. The routine labs division is its core business but is facing headwinds from tariff cuts till 2026 in France, Italy and Belgium and is in the process of increasing volumes that offset that weakness.
Cerba's Specialised Labs, Research, Testing, Inspection and Certification divisions is the key to future growth, cash generation and de-leveraging of the capital structure. The unknown here is the scale and timing of the volume growth as well as growing the backlog for the Research division (where there is a six-month time lag). We have assumed an acceleration in top-line growth only in 2026 for the above three divisions though we suspect that might be a more conservative stance. This will also be key to the refinancing of the RCF, term loan B and senior secured notes in 2027.
Investment Considerations
We are taking a short position in the 2029 Notes as stated below:
- 2029 Notes: The senior notes have declined over the past quarter on the back of negative news flow from other big French restructurings (Altice, Atos) as well as negative headlines from regulatory inspections regarding anti-competition practices. Given its subordinated position and no catalyst in the coming quarters, we are putting a short position at approximately 3% of NAV at 65% (which should take care of borrowing cost) as we feel the company will see not fundamental improvement (which includes volume growth within the routine testing business). We feel that the notes could fall to 50s as market participants see this as a recovery play rather than a yield play. As explained in our write-up - in a downside scenario, the bonds are a binary bet.
- 2028 Notes: At the current trading price of 82% (YTM of 9.1%), the senior secured notes have declined for the same reasons as mentioned above. Given its pari-passu status along with the loans and RCF, the notes are covered from a valuation of the business however the yields on the notes are not compelling for us yet (especially if the notes are extended via an A&E process) and we would wait for a pullback in the price to become more constructive.
Current Trading - Q3 2023
- In the current trading results, Cerba is still suffering from the tough comparisons from the Covid-19 years on its core business of routine tests as well as the research division
- Organic volume growth was strong but the impact from the above dynamic is still offsetting that. The company stated on the Q3 earnings call that leverage will remain elevated at 8.0x and above with deleveraging expected only in 2025.
- The key needle movers will be growth in the Routine Testing and Research divisions as the company expects to gain market share. Specialised Lab revenue growth is expected be in line with the market as it is as the market is already consolidated.
- Q3 2023 revenues were €438 million. Y-o-Y sales decline of 24% due to decrease of CovId-19 testing revenues. Covid-19 now represents 1% of total revenue.
- Y-o-Y sales decline of 12% in the Research Division due to cancellation / early termination of Covid-19 related clinical trials and challenging environment for the life sciences industry.
- Positive growth in the Medical Lab business with a 2.9% increase offsetting a price decrease of 5.3% in France. Volumes grew by 7% in France.
- Gross margin % increased YoY due to improved purchasing conditions and favourable mix shift.
- Q3 2023 EBITDA was €83.7 million (declined by 52.9%) with EBITDA margins declining from 31% to 19% due to decreased Covid-19 testing volumes.
- Positive variation in working capital of €19 million in Q3 is expected to continue into Q4 2023.
- Q3 2023 operating capex was €24.6 million. YTD operating capex totalled €55 million or 3.8 percent of sales.
Housekeeping:
- The next catalyst on this name will be the full reporting of the FY 2023 financial results on the 24th of April 2024 which may prompt a reaction to the trading levels of the bonds and our views.
- Given the tough comparables in the sector from the Covid period, we expect to see progress around the organic volume growth that would offset the tariff cuts. In addition, we would also be watching any acceleration in growth in the Specialised Testing business, contract wins for the Research business and further cost synergies.
Saahil
T: +44 203 192 0200
www.sarria.co.uk