Cube Report (27 May 2021) – Getting it wrong with C&C

Cube Report (27 May 2021) – Getting it wrong with C&C

Hi everyone,

It’s time to put my hands up and say “I got it wrong” with one of the shares I bought in 2019.

C&C Group (CCR) published annual results yesterday, and also announced a rights issue.

Checking the archives, here are some of my historic comments on the stock:

  • April 2020 – “I’m eagerly awaiting an updated balance sheet. Net debt was last seen at £255 million, which I was fine with. The level of available headroom suggests to me that the company should be able to survive. I assume that the banks would give it a covenant waiver, if necessary. This is not my most comfortable holding but at just 1% of my portfolio, I have no problem sleeping at night.
  • June 2020 – “I’m very relieved that C&C made such good progress paying down debt over the last 12 months. I think this has set it up well to survive this economic disaster. If pubs and restaurants re-open in July and there is a gradual recovery for the rest of the year, then we will be set up for a better 2021. I do expect this year’s results to be terrible.”
  • July 2020 – “It does need debt covenant waivers for the time being and as I said in my most recent coverage, I expect this year’s results to be terrible. But I don’t feel forced out of it yet. I’m staying with it for now.”
  • January 2021 – “With C&C, I do have one or two concerns – quite a lot of debt on its balance sheet, and many of its activities are not premium-quality (e.g. wholesaling). I might be persuaded to sell it some day, if the valuation was rich enough.”

As you can see, I have at least been very keenly aware of the balance sheet risk.

But I was hoping for it to avoid raising fresh equity. As someone who tries to only invest in companies whose equity is a rare and increasingly valuable resource, I see yesterday’s outcome as a failure: it’s raising £151 million at a share price of 186p, through a rights issue.

I can take consolation from the fact that the dilution is heavy but not overwhelming, and the existing equity value is impaired but not ruined.

Some of the key metrics around the fundraising and my investment:

  • my entry price was c. 280p in March 2019 (latest share price: 250p, market cap: £830 million)
  • 81 million new shares will be issued. This increases the share count by 26%.
  • pre-Covid, net debt excluding leases was c. £200 million. This rose to €362 million (£311 million) as of February 2021.
  • as of mid-May 2021, net debt including leases was €494 million. Based on a rough estimate of leases, this implies to me that net debt excluding leases had risen further to c. €410 million (£352 million).

So have an increase of around £150 million in net debt (ex leases) from Feb 2020 to May 2021.

A simple interpretation of what’s happening is that the company is raising enough funds to reverse the net debt increase suffered during the pandemic.

The most interesting snippets from the rights issue rationale are as follows:

With approximately 80 per cent. of C&C’s pre-COVID-19 net revenue derived from the on-trade, the prolonged and continued impact of lockdowns and on-trade restrictions has been considerable…

The Group retains sufficient liquidity with cash of approximately €50.3 million as at 21 May 2021 and access to the €450 million Revolving Credit Facility, of which €246.2 million was drawn as at 21 May 2021. The Group had net debt (including leases) of €494.3 million as at 21 May 2021.

With access to €300 million in liquidity, you could almost be forgiven for thinking that C&C doesn’t need fresh funds. But you’d be wrong…

…the Group has agreed, subject to and conditional on the completion of a Minimum Equity Raise by 31 July 2021, amendments to the terms of its indebtedness, whereby the applicable Interest Cover Ratio and Leverage Ratio covenants under the Existing Facilities will be loosened from their original levels for the 12-month period ending 31 August 2022…

Because these Conditional Covenant Waivers granted by the noteholders and lenders under the Group’s Existing Facilities are conditional upon completion of a Minimum Equity Raise by 31 July 2021, the Directors have concluded that it is in the Group’s best interest to proceed with the Rights Issue.

This is fairly black-and-white.

C&C needs covenant waivers, and it won’t get them without raising equity.

The amount demanded by the lenders can be found in the appendix: one set of lenders insists on €125 million, and the other set of lenders are insisting on £125 million.

C&C is raising 20% more than it absolutely needs to, which is reasonable.

The target leverage ratio for management is below 2.0x. Lenders are more flexible than that: if the company raises fresh equity, they will only demand a leverage ratio below 4.5x in August 2022, and below 3.5x thereafter. (Leverage ratio is defined as the ratio of net debt to adjusted EBITDA.)

Adjusted EBITDA in FY 2020 – which we might consider to be a “normal” year – was €154 million (£132 million). This collapsed to negative €29 million in FY 2021.

FY 2022 is going to be difficult, but hopefully we can start to work our way back to “normal” performance, especially considering that the on-trade is back in the UK.

Or in the words of C&C:

With outdoor as well as restricted indoor hospitality once again reopened in the UK, C&C has been able to respond quickly to rapidly evolving demand with outlets traded with for the week ending 16 May 2021 at 65% of the same week in 2019. In addition, Irish hospitality is due to reopen from early June 2021.

My view

In hindsight, I consider this investment to have been a poor one. You can argue that I was “unlucky”, of course – but I don’t think someone who does this for a living should resort to blaming bad luck!

From the point of view of share price performance, I invested at 280p, have received no dividends, and the shares two years later are worth 250p plus around 18p of value in the rights which have been issued to me. Uninspiring stuff.

From the point of view of company performance, I can’t fault management. As far as I can tell, they’ve not made any mistakes. It has just been a terrible time for their industry and for how they are positioned within it. Their brands rely heavily on on-trade consumption.

Am I selling out? Not quite yet. I’m thinking about it. What would you do in my position – hold on for the post-Covid recovery, or cut your losses and move on?

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  • comment-avatar

    I am a newbie investor so any of my comments should bear that in mind. If CCR was an isolated case then this post would have escaped my notice but it isn’t. In the last 24 hours 2 of my holdings have raised fresh equity – Revolution Bars at a hugely discounted price to the institutions totally trashing my holding when the story from management had been positive and Watkin Jones this morning which is less severe but still quite a surprise. I am now wondering which one of my positions will be hit next and what if anything I can do about it before the ‘dilution derby’ starts. The obvious answer is to take profit by top slicing or indeed selling but there are only a few obvious candidates as I have not been trading that long. Whilst this site is not exactly buzzing with participation, maybe there will be some wise words from one or two seasoned investors on here?

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      ChrisK – Just a small correction. Watkins Jones is not a fresh equity raise. It is just the founding family selling a large chunk of their position through what’s called a ‘secondary’ sale. To get such a large chunk of shares away in one go it is traditionally done at a discount to market price. You can obviously read into that what you will about what they think of the near term prospects of the company. It may well be be for any number of reasons: inheritance tax planning, portfolio diversification, concern over future CGT rates, etc, etc. But it is different to a ‘primary’ raise, which is the case for Revolution Bars, and indeed C&C, where management are raising fresh equity.

      Graham – Sorry to hear about this one. Sadly we can’t win them all. Re. whether to sell or buy. Humbly just my two cents as someone who has been in similar positions. I guess it really depends on two things: 1. your view of the pandemic. As you say C&C are largely dependent on the on-trade. If we’re really done with lockdown and on track for a ‘boozy’ summer then perhaps it’s just best to wait for trading to normalise and the share price to hopefully drift back up. If you feel the Indian variant might yet throw a spanner in the works then sell. But I guess that goes for so much of the market. The key thing is that the underlying company remains basically sound so it’s more a view on exogenous factors than an endogenous malaise. 2. Do you have a better trading / investment idea in which to invest the money. Personally I’m struggling a bit right now on that front. Most things seem quite to very expensive. Sadly I don’t do ‘Short’. But am 100% with you on Tesla. New US president seems determined to keep ramping up the spending even as the US economy runs very hot. In general it all feels very 1999 with tech hype, green hype, etc. Am worried it will end in tears sooner rather than later…

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        Hi Phil, thanks very much for sharing your thoughts. I’m probably going to hang on to C&C, unless I need it to bolster my gold position. As you say, it’s hard to find new buy ideas in the current market conditions. Although I do hope to find one or two new ideas in the next little while!

        Regarding the on-trade, I retain a fundementally optimistic view that economic activity – including leisure – will be busy from now on. But perhaps the optimism is just the way I’ve trained my mind to think, in order to be an equity investor? This stuff isn’t easy!!

        All the best and thanks again

        Graham

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    Yes I appreciate Watkins Jones is not a primary raise Phil – aged owner releasing shares for many possible reasons as you say. I should not have lumped them into the same pot but they both have had similar destructive impact on my positions. For what it is worth I started small cap investing with a chunk of spare cash at the start of the pandemic to keep my brain active and establish a routine in the week. It has kept me fascinated and frustrated in equal measures and I have learnt a lot from a standing start, especially from Stockopedia!

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      Fair enough Chris! In which case welcome to the world of investing! I completely second your sentiments: always fascinating, often frustrating and occasionally very rewarding. I must admit when you mentioned those two specific names (Revolution Bars, Watkin Jones) I suspected you might be taking inspiration from the small cap board on Stockopedia. I also love the commentary / general market savvy on there and don’t want to take anything away from them. But sometimes, and I don’t mean to be patronising, I think it can lure new investors into thinking that there is only one valid type of investing: the small cap “special situation” i.e. if you’re not short-term multi-bagging then what’s the point. To me that’s blurring investment and speculation. Your generally taking on much higher levels of risk in the search for ‘Alpha’. Warren Buffet made his name and early fortune on precisely this type of “cigar butt” investing. But it was in an era when information was harder to come by. And precisely because it’s so hard to consistently get right he made his famous switch to focus on “quality” later in career, partly inspired by business partner Charlie Munger. Of course it’s your time, your investment style and your money. I would just urge you not to discount the Terry Smith (highly recommend the FundSmith Investor Manual) / Nick Train high quality / growth styles out of hand. Perhaps experiment with different pots of money. I’m biased because after many years of experimenting I’ve come down firmly in the latter camp. I sleep better at night not owning high risk dogs or investing in low margin sectors. In the case of Revolution Bars that means I would much rather own the Diageos / Fevertrees / etc that supply them. The content not the pipe. Yes, it’s less exciting but I think LT more rewarding. In any case have fun and wish you the best of luck! 

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      Hi Chris,

      Thanks for your comments and allow me to also welcome you to the world of investing! I appreciate you being here!

      With regard to the “dilution derby”, my own tuppence is that I always do my best to avoid unwanted dilution. And in general, I do. I am drawn towards cash-rich companies which also generate lots of cash. These sorts of companies are rarely forced to raise.

      The downside with them is that these companies might not be as “cheap” as the speculative stocks which frequently need to raise – but they are better for sleeping at night. And the results from buying portfolios of “good”, “quality” or “safe” companies, have been pretty good! By the way, I like Phil’s comments a lot – I think he knows what he’s talking about!

      Whatever happens, I think it’s important to have a plan and to stick to it. If your companies are risky and need to raise, that’s something you have to accept. Or if you are more geared towards “safe” companies, then the odds of several of them needing to raise become quite miniscule.

      The way I managed the C&C position was that I kept it small (1%), and I accepted the strong possibility that it might need to raise, although I hoped it wouldn’t.

      The dilution I’m suffering is undesirable, but it’s not terrible – because it’s not a basket case company (yet!). There’s a whole spectrum of risk, with C&C being moderately high (in my opinion). I tend not to invest in the really risky stuff.

      Good luck with your decisions, and I wish you a long and happy investing career!

      Best

      Graham

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  • comment-avatar

    One has to factor in that Markets are there for participants to raise capital . Go through your portfolio and take action by selling anything likely to be affected by covid and buy things likely to benefit . Thats what I did when covid hit . I picked up revolution for 11p per share sold out this week . The raise was annoying as I lost 50% of my paper gain ……but thats what markets are for …..raising capital . I certainly cant complain . The trick is to spot the obvious train wreck coming and hospitality in covid was obvious and still is . Everything is over valued and recovery priced in . Sit on your cash and wait until better opportunities appear . When you look what Beam me up Scotty paid for his Revolution shares and sat on them right through the pandemic , it makes your eyes water ……shear madness . It was never going to end well was it ? My strategy was sell everything affected by covid at the start ( FEB/MAR ) and bought back when the UK vaccine success was announced . I bought things like Saga , carnival , RBG . They are all over valued now ….priced in . Ripe for a set back . Take care out there .

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