Cube Midcap Report (29 July 2020) – Aston Martin is still a tantalising short

Cube Midcap Report (29 July 2020) – Aston Martin is still a tantalising short

Good morning!

Another big results day. I’m particularly interested in:

  • Aston Martin
  • Next
  • Aveva
  • Jupiter
  • Lancashire

I am live at midday today:

Finished at 4pm.


Aston Martin Lagonda

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Market cap £966 million
RNS Half-year Report
Writer disclosure No position.

My biggest regret when it comes to this share is not shorting it, soon after it listed.

But I’m extremely selective when it comes to shorting. I don’t try to catch them all.

It now has a new team, new investors and it’s on a new path which includes Formula One membership.

H1 results don’t look good:

  • revenue down 64% to £146 million
  • loss-making event at the adjusted EBITDA level
  • operating loss of £159 million

Net debt is an enormous £751 million (vs. £844 million a year ago, both figures including c. £110 million in lease liabilities).

It’s always a terrible sign when a business is still in huge debts, even after a massive fundraising exercise.

During H1, Aston Martin raised £682.5 million from share issuance (source: cash flow Statement). The share count exploded. And yet there is still so much leverage at work here.

Where did all the money go? The H1 cash flow statement shows a large operating outflow (£179 million) and a large investing outflow (£160 million). On top of that, there was a hefty interest bill (£31 million) and transaction fees on the fundraising (£21 million).

Those four categories add up to £391 million and go a long way towards explaining why Aston Martin failed to achieve all that much headway in its debt reduction.

Comment by the new Executive Chairman, Lawrence Stroll:

Obviously, it has been a challenging period with our dealers and factories closed due to Covid-19, in addition to aligning our sales with inventory with the associated impact on financial performance as we reposition for future success. However, I have been most impressed that through this most challenging of times we have been able to reduce our dealers’ sports car inventory by 869 units.

Too much inventory was a factor I mentioned in the Q1 results. AML wants its dealer inventory in future to reflect a “luxury norm”, i.e. very little of it.

That’s been a factor in the revenue decline – AML has been selling less through the wholesale channel, as it tries to “rebalance supply to demand”. The demand for very expensive sports cars must be lower than previously thought.

Outlook

AML reiterates that this is a “reset period” – it has to sell less, while inventories are too high, in order to fix the supply problem and become a “true luxury company”.

There’s also the small problem of Covid-19 and the economiy:

Trading remains challenging in many markets and the pace of emergence from lockdown and consumer recovery varies significantly. 

My view

I wouldn’t touch these shares and I’m wondering if it might be a good short candidate, even after all the fundraising.

This is the debt picture:

The senior secured notes are at a blended interest rate of around 8% (my calculation). Not cheap.

In July, the company has borrowed another US $68 million at 12%, plus another £25 million.

I would need to do a lot more work, to visualise what the company is planning to look like next year and beyond. It says that it has a clear ambition to be a true luxury car company: how small might revenues need to get, to fulfil that vision?

Official consensus says that revenue will recover to c. £1.2 billion next year. That looks very unlikely to me.

For now, AML investors need to keep an eye on sales of the company’s first SUV, the DBX. This is reported to start at £158,000.

The luxury SUV market has so many impressive vehicles at less than £100k. Can the DBX really find a profitable niche, when there are so many cheaper models from prestigious manufacturers? I’m not sure.

 


Next

Market cap £7.4 billion
RNS Trading Statement
Writer disclosure Long NXT.

Wonderful expectation management from Next. Full-price sales are only down 28% in Q2 (May – July).

Over the last six weeks, full-price sales are only down 8%:

If you check the April trading statement, you see that the company was modelling full-price sales for this year to be down between 30% and 40%.

For Q2 specifically, it was modelling full-price sales down between 50% and 60%.

So the minus 28% result is a vast improvement on that.

Overview

Some key points:

  • the 28% decline in full-price sales is derived from a 9% increase in online sales, and a 32% reduction in retail sales.

I am one of the many people who are shopping more online, instead of shopping in stores under the conditions imposed by governments. Makes perfect sense that this trend will continue.

  • stress test scenarios now model full-price sales for the year down 18% to 33% (rather than down 50% to 60%).

Net debt at year-end is forecast to reduce by £460 million, which is only a modest improvement on the base scenario envisaged in April. However, the company does have a lot of discretion over this figure and I am personally more interested in the improvement in earnings than in faster debt reduction, in these circumstances.

Net debt is estimated to finish the year at £650 million.

  • full-year PBT will be £195 million under the base-case scenario

Naturally, the £7.4 bilion market cap looks expensive against current-year earnings. The market understands that this was an exceptional year, and I agree with the consensus view that lockdown isn’t happening again, at least not on a national level.

There is still a strong belief in the existence of a very deadly virus, and I don’t see social distancing and other measures ending soon. But if conditions are somewhat normal from now on, then companies like Next can function in a reasonable way and not entirely dissimilar to how they did before.

Next’s very strong online capabilities are a competitive advantage in this environment, at least in my view.

Warehouse picking capacity is back around where it was before, despite social distancing. 24-hour shift patterns and other steps are being taken to further increase capacity:

Lower returns – an interesting snippet, that Next has benefited from lower returns rates. This is because Childrenswear/Homeware are still selling well, while Dresses/Formalwear aren’t. The former categories have low returns, while the latter categories have high returns.

Only 23% of despatched items (by value) were returned in Q2, versus 42% last year:

Scenario Planning

Next doesn’t really do “forecasts”, as such. Instead, it imagines various possible scenarios, and plans ahead for them.

As noted above, it now thinks that full-year, full-price sales will be down between 18% and 33%. Down 26% is the “central scenario”.

The impact on cash flow is offset by reduced wages, a reduced tax burden, and reduced lending to customers.

The central scenario sees a near-term cash impact of £210 million from lost sales (although in a bear case scenario, the impact would be £360 million).

Now let’s look at the additional cash resources which Next plans to generate. It is now looking to save £690 million versus the pre-Covid plan.

In April, it was looking save £799 million versus the pre-Covid plan. But since things aren’t as bad as feared, it doesn’t need to take all of the planned actions. The main change since April is that Next is no longer planning to recall its loan to its Employee Share Ownership Trust (ESOT).

Net debt will reduce by between £314 million and £464 million. It’s fantastic that Next had the flexibility, going into this crisis, to protect itself to such an extent. As noted above, net debt should close the year at £648 million.

If only all companies were so transparent with their planned balance sheet:

As you can see, Next is planning to have lots of headroom, even in a bearish scenario.

My view

Obviously, I’m positive on this one! And I think Keith Ashworth-Lord might have been too quick to get rid of this share (though I agree with him dumping Revolution Bars and Restaurant Group).

Since 2015, Next’s after-tax profit has been c. £600 million, and EPS has been boosted by a declining share count.

Cash conversion has historically been good and in future, Next should benefit from weaker competition. I don’t think it’s good for society, but it’s good for large companies that their power increases as the economy becomes more regulated and more rigid.

The High Street has been decimated and the future belongs to those with a strong online presence, excellent distribution capabilities and trusted customer service.

I’m happy to continue holding this one.

 


Aveva

Market cap £6.9 billion
RNS Q1 Trading Update
Writer disclosure No position.

This highly-rated software group announces an OK Q1:

  • organic revenue, at constant FX, down 3.5%
  • subscription revenue +30% as company moves to subscription model

Despite the Covid-19 related disruption, demand for AVEVA’s software has been robust, due to its ability to drive efficiency, flexibility and sustainability for customers across a wide range of industries, with particularly good demand for Cloud solutions.

Aveva’s products are used in a very wide range of industries, and Covid-19 is seen as “accelerating the digitalisation of the industrial world”.

Net cash is good at £110 million, and the company will pay a dividend. It has made no redundancies and furloughed no staff.

My view

If I was assembling a collection of good-quality FTSE-250 stocks, this would probably end up in the basket. Valuation is a concern.

 


Jupiter

Market cap £1.3 billion
RNS Interim Report and Accounts
Writer disclosure No position.

At the other end of the valuation spectrum, this one has been looking cheap for some time. And it’s even cheaper now, after the Corona-crisis.

The reason is that it doesn’t have any particularly interesting niche in the asset management sphere. In a world of passive ETFs, active managers need something special to attract flows.

Net outflows were £2 billion and AUM fell by £3.6 billion over the six-month period, down to £39.2 billion.

Profits and EPS are squeezed, the dividend has less cover, and the operating margin de-leverages. It’s all quite grim:

A large (£370 million) acquisition should give H2 a boost. Even so, I can’t get excited about this.

 


Lancashire

Market cap £1.9 billion
RNS Q2 2020 Earnings Release
Writer disclosure No position.

This specialist insurer gives us a “pre-Covid” profit estimate.

The combined ratio was 88.9% before Covid, or 106.9% after Covid (anything less than 100% is an underwriting profit, more than 100% is an underwriting loss).

Fair enough – in a “normal” year, we would have seen a decent proit.

The company is growing well, just take a look at the increase in net premiums written ($ million):

Unfortunately, there are no profits to be had this time around. The Covid impact to Lancashire is now estimated at $42 million, an uncertain figure.

Last year’s more benign environment saw H1 underwriting income of $79 million and comprehensive income of $69 million.

The big theme in insurance now is very high rate increases. Florida catastophe renewals are up an incredible 20%-30%.

The CEO, like others in the business, sees opportunity:

I believe that the economic fundamentals now dictate that this pricing trend is likely to strengthen throughout 2020 and into 2021 across a number of our business lines, and that current market conditions present an attractive opportunity for growth consistent with our strategy of deploying capital in line with the insurance market cycle.

The interim dividend is held flat.

My view – diluted book value per share is $6.16, or 475p. The current share price is at a 60% premium to this – not sure if I’d be willing to pay up for it, although the prospects for returns do appear to be very good over the next few years.

 


 

That will do it for today, thanks for dropping by!

Graham

 

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    Now Porshe are practically a mass production car maker and all the Hoy Polloy drive 2nd hand Cayanne SUV Aston might just have a chance with a true limited production Lux SUV . After all, even my neighour ( who is a JCB operator ) drives a Cayanne . There as common as muck and terrible investments if you want to lose bucket loads of dosh on fuel and dep . My neighbour only uses his once per week to go to the pub and impress his mates . The rest of the time he drives a cheap 4wd truck and an old vauxhall Corsa ! Does about 18 mpg so thats probably why . You can always tell the real money from the posuers as the real deal drive em as thier daily driver and bugger the fuel bill ! Fuel being an insignificant cost to the genuine rich in ownership terms !

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