Selecta - Competing Forces

All,

Please find our updated analysis of Selecta here.

The company is arbitraging a nearly undiminished backlog of €60m one-offs with the improved economics it achieves from its remaining and its new fleet. At the current rate of machine reduction, and taking into account management’s continued resistance to guiding for a bottom in the fleet, we expect that further one-offs will be booked well into 2024. Still, Selecta continue on their road to recovery. Margins continue strong and are getting stronger. While price rises still merely offset COGS inflation and volume loss (from machine reduction), we can see the progress now in the Expenses line, where the roll-out of telemetry now requires a whopping €10m / Quarter less staff cost than last year. The financials are an arbitrage of competing forces 

Investment Rationale:

- We hold a big 7% position, split as a strip across the SSNs and 2LNs and Prefs. Prices are certainly up from earlier in the year, but we were prepared then to leave the first rally on the table, because we could not possibly see a refinancing. That changed (late) after the Q2 results. A straight refi is not our base case yet, but it has certainly entered the realm of possibilities. 

- Buying the “strip" is not a simple yield trade and we fully expect to have a discussion with KKR towards maturities, but in the meantime, we expect Selecta to do well from a) a slow, but steady return to the office, b) a re-build of its GM towards 60%, c) cost-cutting through telemetry and d) potentially a massive driver: the Olympics generating traffic in its public segment. With that growth we also expect multiples expansion and therefore much improved bond and even Pref prices. We'll regard a clean refinancing as upside - for now.

- Risk comes primarily from the renegotiation of the SBB contract. We are concerned this contract was at the heart of the profitability in its home-market Switzerland and that economics are now reduced. We have not observed any adverse movement in the Q3 results, but still fear a delayed impact.

Volume:

- Revenue turned YoY negative for the first time this year as price rises don’t yet quite offset cost inflation and loss of volume from reduced machine volumes.

- Pressed on the call for guidance on when the machine park would stabilise, management again offered no comfort or guidance. 

- The machine culling seems well controlled and targeted - as the improved expense metrics confirm, but we wouldn’t mind some comfort and can’t imagine the shareholder gets the same non-answer...

Margins:

- Prices rose 7% in 2022 but volumes fell 8.5%, causing a 1.5% sales decline in Q3 2023. This is attributed to prioritizing the roll-out of the more profitable food tech business, which often replaces older existing machines, contributing less in sales than in margin. 

- The company plans for 2024 to also mostly offset volume with price, before there should be a catch-up effect in 2025.

- Food tech expansion in Germany, with higher margin machine replacements, is having a highly positive effect on Gross Margin.

- The company seems to be withdrawing from the Italian market where it must be running a very unprofitable business. 

Expenses and one-off Charges:

- Personnel and operating costs dropped with lower machine numbers and more telemetry roll-out. This seems to document that management’s plan is working, despite not being directly focussed on density.

- One-off charges remain an obscure subject at Selecta with no particular efforts made to bring light to the situation. One-off charges continue to run partially through Changes in Working Capital, while also appearing scattered elsewhere in the OCF.

- On our calculations charges will remain at current elevated levels through the end of the year and probably do not include any payments to the Dutch authorities for the Autobar tax liability. 

Looking forward to discuss,

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk