Selecta - Beyond the fleet
All,
Please find our updated analysis on Selecta here.
To grow all the way into its capital structure and put KKR’s equity back into the money, Selecta needs more pass-through, more employees to return to their offices, fewer routes to service and needs to roll out more profitable machines. None of this we saw in the Q123 results, nor did we sense that it’s immediately around the corner. The strategy of severing contracts on unprofitable machines is absolutely the right one. It works for the SSNs and it might work (or might not) for the 2LNs, but on its own, it isn’t enough for the perps and certainly not for KKR.
Investment Considerations:
- We are still on the sidelines. Safe for a return of the pandemic, another material drop in performance looks unlikely now. So what could be wrong with owning the SSNs for instance if a drop of - say 10 points - looks unlikely, but we are earning a YTM of 13% cash into a 2026 refinancing/restructuring that has us covered under almost any scenario we have modelled?
- So far, both, the fleet and gross profit are falling in a straight line. The former may not have to turn around entirely to begin to support the latter, but we’d ideally like to see some stabilisation in either metric before we commit.
- We are keeping the finger on the button, but it’s just not quite ready yet for us.
Gross Margin:
- Clue as to what could go wrong: We didn’t model all the scenarios: Selecta used to generate a gross margin of 60%+. However, contract negotiations since seem to have been tough and the company is now at 53% and falling. Annualised that’s €100m EBITDA missing - not due to machine park reduction, but primarily for failure of passing through inflation. This will take time to rebuild and in all scenarios, we assume it will. But if we are wrong and it falls further for longer and takes yet longer to turn around, then we’d likely lose money on the trade.
- If Gross Margin can be re-built in full through 2025, then the 2LNs should also be covered.
- At present however, we would like to first see a stabilisation of the gross margin at current levels before we step in.
- Management last year promised that with animalisation of CPI figures, its hand would be strengthened in pass-through negotiations with its clients. As of Q123, however, gross margin was still falling.
Machine Park:
- Moreover, we see the machine park still shrinking as well. We are fully on board with the strategy to cut the vast numbers of unprofitable machines that Selecta are servicing. Vending - like many other scale businesses - is an 80/20 business, where 80% of profits are generated by 20% of machines. But in order to grow into its capital structure, Selecta should really begin to roll out enough profitable new machines to stabilise the numbers - we think. Exactly how many machines Selecta would have to place anew vs. terminate is very difficult to say but we’d imagine some kind of visible trade-off. For now, however, the fleet is still falling in a straight line, providing no comfort.
One-Offs:
- Management has been transparent about its “one-off” recurrence. These items should add up to another €70m outflow for the remainder of FY23, providing another almost 0.4x leverage on its own.
- Largest items in this line are a €28m tax liability stemming from Selecta’s takeover of Autobar. Timing will be subject to further hearings in the Netherlands, but overall the outflow is expected for H223.
- The next largest category, although not clearly defined relates to the drastic fleet reduction. The company has to pay termination fees, build back spaces where the machines stood, pay for transport etc. for thousands of machines. While these machines have already been de-recognised in the financials, they often remain exactly where they were and the expense has yet to occur.
- We expect a continuous “one-off” expense of €20m p.a. to remain and to be added to this year’s bills as well (included in the €70m estimate).
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk