Rekeep - Recent weakness justified?

All,

Please find our updated Rekeep model here. 

Post the Q2 numbers, Rekeep bonds have traded down, widening by 100-150bps as investors show some concerns regarding tender levels, working capital movement, loss of Saudi contract and the level of debt associated with factoring facilities. We remain a little more sanguine on the name and expect the upcoming quarters, mainly Q4, to reverse some of these concerns. 

Investment Rationale:

- We maintain our 3% long position in the Senior Secured Bonds. We acknowledge the level of factoring and non-bond debt (factoring etc.) but in relative terms, there is still limited debt ahead of the bonds. 

- We acknowledge some of the market’s concerns re: tendering levels and working capital swings, but we expect working capital to normalise throughout H2, which will lower the gross debt figure, another concern of investors. 

- Otherwise, given the non-discretionary nature of its revenue and the quality of its customer base and order book, we expect Q3 and Q4 results to be boring as usual. 

- Despite the concerns above, we believe investors are compensated for the risk with 12% YTM. There is limited debt ahead of the Senior Secured bonds, stable business and a strong backlog supporting current trading levels. 

Tendering levels/Backlog:

- Investors have raised concerns on the reducing Backlog/Revenue ratio, which has fallen from over 3x to 2.2x. However, the contracts are accounted for under historical tender values, not including inflationary adjustments, versus revenue which is inflationary adjusted. Also influencing the ratio the cancelled contract which was awarded to Rekeep in Q4 last year but had to be cancelled as the tendering entity had not followed the correct procedure. 

- In addition, tendering activity was lower in H123 due to a new Italian code of public tenders which was released in July 2023. Tendering entities delayed the process, preferring to launch tenders under the new regime. We therefore expect a higher tendering level to be visible in H2 23, and in line with prior years, Rekeep to maintain its win ratio, which should further improve the backlog. Comparing tender wins in Q2 to historical levels does demonstrate a dip below the average, but within the norms for Rekeep. 

Working Capital:

- In essence, Net working capital has increased due to two reasons: 

- Natural delay in invoicing the adjustments for energy costs in FY22. This is normally done in Q2 of the following year, which in less volatile energy markets has limited impact on working capital. However, the price adjustments, which are permitted under the contract, have not been invoiced yet. This should work itself out of the system in the upcoming quarters. 

- Secondly, energy suppliers continue to require advance payment which historically was funded with reverse factoring. Rekeep have arranged a new €60m facility in April, which will reduce the usage of reverse factoring. This should phase out over H2.  

- Rekeep management expects a reduction in leverage due to reducing net working capital from the reversal of the energy prices, the majority of which is expected in Q4.  

Factoring Facilities:

- The shortening of payment terms dictated by the energy suppliers appears to be permanent, thus requiring an earlier cash outflow from Rekeep and binding more capital. Rekeep has used factoring and the new facility to plug the outflow and all else being equal, leverage has increased. We don’t see this impact reversing in the coming quarters. 

- However, we do expect the make-up of the gross debt to change, with the factoring lowering in time due to the drawdown of the new facility. As of Q2 there was no corresponding meaningful reduction in factoring utilisation. This is partially explained by the cash balances being €20m higher, but there is some concern that the factoring levels have not reduced substantially on the back of the drawdown of the new facility. This should be a timing issue and we expect the factoring lines to reduce into year-end.  

Saudi Contract:

- In April 2023, Rekeep received a termination notice from its customer for cleaning 4 lines in the Riyadh metro. Rekeep has counterclaimed with an arbitration hearing due in FY25. 

- Rekeep has taken a €6.2m provision in their accounts and expects this provision to result in a cash outflow later this year. The payments are due to layoffs and set-up costs which are no longer appropriate. The Company have counterclaimed against the Riyadh authority but have not disclosed the quantity of the counter-claim. 

- The contract is not included in the backlog. It is not a reason for the drop in backlog as it never was included in the backlog. 

Projections:

- Even allowing for the closure of the Saudi operations, including the outflow of €6.2m in FY23, we still see leverage staying at 3.4x including the fine. This would be static versus current levels, in line with the Company's guidance. Note this is after a net increase in Working Capital, which the Company should absorb from their earnings.  

- There is a fear that Rekeep could seek further business outside its core geographical area, especially given the build-up in cash balances. However, we don’t get that sense from talking to management.

Happy to discuss.

Tomás

E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk