Sarria: Cerba - Back into the fire - Positioning
All,
Please find our updated model on Cerba here.
The Q4 results do not alter our views that Cerba remains a significantly overleveraged business with poor interest coverage. In April, we took profit and covered our short position as we were slightly surprised by how quickly the bonds dropped. There was plenty of negative news (discussions with advisers & CEO resigning), but we covered the shorts because of the lack of near-term maturities. However, we acknowledge we were wrong, and we now model that the Company will run out of cash in Q3 2026, potentially even later this year and we don’t see an easy LME scenario without coming much closer to a restructuring that should send bonds further down.
Investment Rationale:
- We are shorting 4% of Cerba seniors at 75%. We are not shorting the Cerba subs, as some clients have indicated borrow is difficult. The structure is unsustainable, and we fundamentally believe that the senior secured debt is not fully covered.
- We went short Cerba in early February, taking a 2% short position in the seniors at 88% and a 1% short position in the subs at 68%. In mid-April, we covered those shorts at 80% and 39%, respectively, locking in 8 points and 29 points. In hindsight, we were wrong to cover the shorts.
- We outlined in February that Cerba had sufficient liquidity for the next 12 months and, with a little management, could survive 2 years. That has changed. The business could run out of cash as early as Q3 2025 and definitely will not be able to trade beyond Q1 2026. Therefore, we are re-taking a short position.
- We acknowledge we covered the short too early, with the bonds trading further down post the Q4 numbers.
- The ultimate downside for the senior unsecured is zero. On the Senior Secured Notes, we see a fair value at c. 50%.
Potential Positive Catalysts:
- The chances of an equity injection are slim at this stage. The equity is definitely out of the money, and the only reason EQT would inject money is to capture some discount from current levels.
- Adjusting for price deflation imposed by the French state, volume increased 8% in FY24 over FY23 in the Routine Lab France segment. We have modelled a similar growth for FY25 (9% growth), reducing it to 6% in FY26.
- With tariffs now stabilised, the volume will translate into sales as the year evolves, resulting in a 4% growth in Revenue for FY25 and 6% in FY26.
- This results in EBITDA (pre-IFRS 16) growth of 10% for FY25 and 18% in FY26. However, even with these growth rates, FCF is not sufficient to meet interest costs.
- Our model does not include any of the cost savings programs referred to in the Q4 conference call. Some of the savings may emerge, but we are modelling that they are absorbed by normal inflationary pressures from wages and raw materials. This may, however, bring some ray of light to investors.
Consumer Biology France:
- This is the segment where the French NHS applied a price reduction from mid-September 2024 due to the constraint that the yearly spend for Medical diagnosis was capped at a growth of 0.4% p.a.. The agreement reached in December broadly left the new tariffs imposed in September in place, except to increase the tariff on a selected range of tests to soften the price cut applied. The impact of this is to bring an additional €10m of revenue and EBITDA in FY25. Additionally, there are to be no tariff changes until December 2026.
- Using Jan 2023 as a base, Q1-Q3 2024 prices were only subject to a maximum of 10.5% reduction, whereas Q1-Q4 2025 will be subject to a 16% reduction. To leave revenue static, volumes would need to increase 8.5%, 7.3%, and 5.5% in Q1, Q2 and Q3, on a year-on-year basis. Q4 2024 was already subject to the lower tariffs, so flat is sufficient to keep revenue static.
Model assumptions:
- The Company includes €147m adjustments, reflecting its ambitions in terms of synergies, savings and transformation plans for the FY25 & FY26. How much of this is justified?
- The Company has not provided any details to judge whether these savings are from a cost reduction in fixed costs or higher efficiency, driving down the variable cost. However, we outline below that we are including some cost savings and top-line growth, although not as large as the Company expects.
- The largest segment of the €147m adjustments is the Company’s cost savings program of €100m split across all areas of the business, €75m visible in FY25 and a further €25m in 2026. We would expect the Company to make some savings, however, some of these will be used to absorb inflationary pressures that all businesses are subject to. To put into context, if we left all cost elements flat (as % of revenue) from FY24 to FY26, i.e. flat EBITDAR margin, EBITDAR would be €60m lower in FY26. Essentially, our projections are expecting cost savings of €20m in FY25 and an additional €40m in FY26. Any savings above this rate are difficult to justify at this point. Note, we haven’t incurred any non-recurring cash outflow for these savings in our model.
- The other subset of the €147m adjustments, €47m, relates to top-line initiatives to boost revenue. Assuming a 23% margin, this would amount to c.€200m additional revenue. Our model already includes €150m of additional revenue from various growth assumptions, and although this is lower than the Company plans, we again don’t see a compelling reason to increase our growth assumptions.
Research Segment:
- The research segment, which is a c. €200m revenue business, has some upcoming headwinds. The backlog in December was €347m, which is healthy and excludes the BARDA study, which is funded by the US government. The reason for the exclusion is that the study is currently under review and may be terminated. This relates to the US government reviewing its external contracts.
- Separately, a review of the business led to an impairment of the asset as growth opportunities are lower than at the time of the acquisition. A substantial portion of the research backlog relies on strong input from US government agencies. We need to do additional work on this segment, and the impact of the loss of NGO contracts could have on Cerba’s profitability.
Next Steps:
- The Company are due to publish its Q1 results on May 19th. We do not expect any announcements from them concerning balance sheet restructuring. The Q1 results call will likely focus on the volume levels within Consumer Biology and any update on the potential termination of the US study within the research segment.
- We expect the Company will have to draw on its RCF in the quarter. The bilateral loans are reduced by c. €40m p.a., although we do not know the exact timings of the paydown. With an expected outflow in Working capital and taxes, the Company will have negative cash flow post-interest of c.€50m, which will be funded from the RCF.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk