Cube Report (27 May 2021) – Getting it wrong with C&C
It’s time to put my hands up and say “I got it wrong” with one of the shares I bought in 2019.
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.
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?