Frigoglass - A matter of timing
All,
Please find our new analysis of Frigoglass here.
While we still have some open questions, we feel we have substantially concluded on our view of Frigoglass. Following the fire at its Romanian plant last summer, the company has displayed astonishing stability - so much so, that we are feeling a little unsure about extrapolating that. Meanwhile, cash is running low outside Nigeria and the timing of insurance payments for the fire becomes important in the context of rebuilding the plant this year.
Proportionate Beta Glass:
- The Glass division is for the most part only 55% owned, but 100% consolidated. We are looking at Frigoglass on a proportionate basis, i.e. we take 100% of EBITDA, subtract the EBITDA Frigoglass does not own in Operating Cash Flow, and solve down for the cash movement outside of Nigeria. This leaves us with an only slightly conservative calculation. The plastics and bottle tops business in Nigeria are held for a slightly higher proportion and we should theoretically plan for a slightly lower CapEx than the consolidated, but in the overall scheme we should come close enough.
- The convoluted ownership of the plant and some of its contracts, are a weakness of the credit.
Fire:
- Frigoglass’ Rumanian ICM plant - by far the largest in the business and running at 90% capacity - burned down in June. Production has been shifted to the Russian plant, but on paper that plant should be too small to take the volume.
- Almost inconceivably, business volume has held up in Q321 and working capital also seems in order. We conclude that relatively low volume production of “fridges” should be a lowly automated affair, which is why it is based in EM countries. But we are still scratching our heads about how smoothly the transition seems to have gone.
- Frigoglass seem to be fully insured, both for the replacement of equipment with new machinery, as well as for business interruption. A first €15m tranche has been paid in September, but the extent of further payment, or their timing remain uncertain.
- Management have stated they expect the volume to be fully replicated from the Russian plant by January 2021 - last month - and that the Romanian plant should be rebuilt before the end of the year.
Cash Flow:
- If business is indeed largely unimpaired, then Frigoglass may benefit from a temporary line to draw some extra €20m to be comfortable. This amount is entirely within its baskets and we imagine someone in Romania will want that plant rebuilt and avoid unemployment. The amount should not concern bondholders too much and represents less than half a turn of additional leverage, which should for the most part be repaid with insurance claims once those come in.
- Q3 margins were some 200bps lower than we might have otherwise assumed. But in the context of the Romanian ordeal that is surprisingly little and is probably owed to make shift transport and logistics, as well as short-term orders for supplies in Russia.
Risks:
- The main risk is that Frigoglass lose a large customer any disruption in connection with this incident.
- Another risk is that while Q3 so magically held up (almost), the music did indeed stop in Q4 (to December).
- Thirdly, Business is somewhat seasonal, and Q1 typically sees a large cash outflow. While it is possible that the peak outflow actually lies in Q2, we conclude that if the company needs fresh cash, it will need the cash in Q1, i.e. have to receive it in the coming eight weeks, i.e. ask for it now.
- War in the Ukraine: The Russian plant is just on the other side of the Ukraine. Should East and West indeed depend into armed conflict, Frigoglass would have no other plant in Europe to shift this volume to.
- If any of the above risks impairs the company’s business to the point the balance sheet needs restructuring - again - then on the one hand, bondholders are not in a strong position to negotiate with a family that controls its largest customer and with that significantly influences well over half of Frigoglass’ revenue. On the other, therein lies its stability.
Investment Considerations:
- The bonds are yielding 13% to maturity, which we feel is not enough to compensate us for the above risks at the moment. However, the above risks are altogether short-term in nature.
- On the surface, it seems to us that despite major operational upheaval, the business continues unimpaired. If we can substantiate that before the Q4 reporting in March, we would indeed look at Frigoglass from a yield perspective.
- For now, however we are holding off with an investment until we better understand:
- how the largest ICM plant could so smoothly and quickly be replicated in Russia.
- if we find reason to believe Q4 will show a bigger impact from the fire than Q3 did and consequently if the company might have dropped a client.
- if the Ukraine conflict de-escalates.
- if the company asks for fresh cash in the next three weeks.
- So it's perhaps just a matter of timing and of a little more colour on the production shift from Romania.
Please reach out to discuss,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003