Lowell - Away from Corona it's too little, too slow
All,
The Lowell call ended without allowing our questions, so there are some open areas, but overall the situation is well understood.
Cash EBITDA leverage stats look great, given that during Q2 litigation collection was badly affected and that generally Forward Flow (back book collections) was naturally less affected than first time collections. To what extent that may change when the end of furlough schemes takes its toll remains to be seen, but in general that should be a reasonably stable business.
CF:
- Portfolio acquisition was down E25m YoY, which is fair enough in this environment, but is important to understand, as it drives a number of shifts in the apparent profitability of the company.
- The high share of forward flow collections in Q2 drove approx. E20m of additional cash GM / EBITDA relative to normal collection profiles.
- Overall excess proceeds (Income on Portfolio Investments) were up E8m on last year, mostly given the larger book.
- The company took a write-down of assets of E10m to reflect the postponement of collections only. That seems fair, but impacts GM by E-70m YoY.
- Collection Activity Cost was down E25m, mostly due to low primary collection / litigation collection in the quarter, and is expected to resume in Q3 - in line with the activity itself.
- Other Expenses were also down E10m, along with general activity and are expected to resume.
- 3PC revenue (GM) was only E45m vs E57m in Q219, due to clients dragging hand-over of delinquents during the early phase of Covid-19.
In sum therefore, FCF was E45m better than Q219, but naturally that came at the expense of the balance sheet, where growth is now (naturally) stalling.
Guidance:
Portfolio Purchases are expected to total E300m this year, implying a small improvement, but remain E50m above the calculated replacement rate - in line with our estimates that the rate at which the P&L remains constant lies some E45m above that at which the BS remains constant.
Business Trajectory (away from Covid-19):
- The company inserted a slide (#12) to show that its cash production is rising and that it generates positive "Excess Cash (Flow)". The trajectory shown is positive and that is true. There is a positive trend in the numbers. But it is small. The "Excess Cash (Flow)” is calculated before constantly recurring non-recurring expenses of more than E-50m and the replacement rate used is that of the BS, thus another E-50m too low to keep earnings stable. So Levered FCF still remains under water, if a little less so. Also note that the LTM June figure would be approx E-18m lower w/o Coronavirus, which would still yield a positive trend, but much less so. Meanwhile, of course, net debt has grown as well,
Conclusion:
- We cannot see signs of significant cost reduction, which we continue to deem necessary to achieve positive sustainable levered free cashflows in the next 12 months.
- We do recognise a slow, but positive trend towards breaking even at levered FCF level. That still would not create equity underneath the bonds, but it makes it again imaginable.
- Our concern is that the company may not have the time to break even on the current rate of improvements before a refinancing becomes necessary.
- Management stress that liquidity is sufficient and as long as growth is subdued, that remains correct. But it won’t be able to take part in the Corona Wave without a larger RCF or otherwise additional funds and the RCFs mature at the end of next year. Lack of progress on the extension / expansion of the RCF is going to weigh on the company’s ability yo purchase more debt next year.
- Following the recent failure to orchestrate a grand refinancing with the injection of up to E400m by the shareholders, we remain somewhat unclear as to how large the contingent of investors really is that believes in this Cash EBITDA nonsense. Cash EBITDA leverage is going to look great with fewer receivables collected, while debt will fall with lower purchases. For the moment the market seems to understand that.
We will be updating our model in due course, but happy to discuss findings.
Wolfgang