Selecta - Stuff of Champions - Positioning
All,
Please find our updated analysis here.
Every once in a while a name begins to make a lot of sense - and we are the last to see it. It’s Selecta’s turn. If following Q1 the vendor was on the edge, today it is one step further - but in the right direction. We are certainly off the fence as we abandon our previous measure of success and instead take queue from the first perceivable CPI pass-throughs, as well as notable cost control and thus a rebuild of margins. In addition, we are looking forward a year to names that we think will benefit from France’s hosting of the Summer Olympics 2024. We think the champion will be Selecta with its significant exposure to rail and air travel should be a prime beneficiary, just like - we believe - it was in the past when Germany hosted the World Cup.
Investment Rationale:
- We are taking a big 7% position, split as a strip across the SSNs around 92c/€, 2LNs at 71c/€ and Prefs probably at 50c/€ now. 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) yesterday. 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 will be funding the purchase with the liquidation of some older positions - some for scraps - in: Casino, Adler AGPS 26s (holding on to the rest), Naviera Armas and Aggregate. See separate email tomorrow.
Model:
- Fleet shrinkage has been even faster than modelled. We are apprehensive of the continued shrinkage, as we think the company has largely arrived at fair margins. To restructure, it would be good to have some size remaining.
- The all-time-high SMD of 13.1 is primarily a result of the faster shrinkage of low-revenue, private machines vs. high-revenue public machines.
- New (and overdue) is the raising of prices in H123 by 6%. Management had promised late 2022 already that price raising would become easier once CPI stats were available. We were disappointed not to see the evidence in the Q4 or Q1 results, but here it is now and there should be more coming.
- Margin, therefore, has picked up very strongly. Pre-IFRS16 EBITDA now stands at 16% of sales and with only 4.8% of CapEx, we think this should be the ceiling of cash production by normal retail metrics.
- The company renegotiated its contract with SBB. This contract is the foundation of Selecta and we think still sits at the heart of the considerable profitability of the Swiss business. Manage (understandably) did not elaborate on the question if the new economics wil be similar to those in the past.
Route Density:
- Management spelled out more clearly than ever their departure from the route density model pursued by generations of predecessors.
- Telemetry is the new paradigm, allowing companies to control price and service level remotely, machine by machine. The technology adds a level of granularity to the management of the fleet that - for now - trumps the general density model. All new machines are digital and telemetry penetration has now surpassed 70%, looking set to surpass 80% by year-end.
Miscellaneous:
- In the first half of 2023 the company installed merely 2,860 machines - half of which are big new fresh-food vendors, but cut ca. 23,000. we would not mind seeing the bottom of this development, but management indicated that this trend would continue through the end of the year.
- Selecta renegotiated its contract with SBB. This is the original contract the company was founded on in 1957. The renegotiation was the first of its kind and we are concerned it was behind the extraordinary profitability of the Swiss business. We are concerned that economics following the renegotiation are no longer what they used to be. Management understandably refused to comment on an individual client contract, but we would have liked some more reassurance - particularly as it was SBB who asked for the review (naturally).
- Fresh-Food pilot machines at SNCF are doing well. Little vandalisation. lots of roll-out opportunities in other countries as well as hospitals, amusement parks etc. Comes at the expense of taking out plain machines for new ones.
- We were the only ones asking a question on the call yesterday. What’s cooking?
Here to discuss,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk