One stock, different outcomes, same story – why you need cashflow and balance sheet forecasts to understand debt
When I wrote the (very) recent blog on Victoria PLC (https://progressive-research.com/insights/size-of-a-cow-victoria-plc-and-how-to-keep-things-in-perspective/) I was not expecting the trading outlook in the then-imminent H1 results to be so grim. After all, the company had communicated with the market in its AGM statement just seven weeks before. But following the H1 results on 22 November, underlying EBITDA forecasts for the full year (FY24) were cut by around 15%.
The purpose of our original blog was to illustrate how the market can get hung up on relatively small issues, in this case the qualified audit report resulting from the Hanover Flooring pantomime, while failing to grasp the actual scale of the bigger issues, in this case debt and the impact of higher interest rates after refinancing. The basic point of the blog still stands and is perhaps enhanced by the H1 results.
At the time of writing that blog I was also looking for a company with significant debt to use as an illustrative base to demonstrate how a moderate change in operational performance can, by impeding debt reduction, have a considerable impact on a stock, sending the company off in a different direction even though the investment case posited to investors might never change.
It seemed a bit unfair to use Victoria as the base when its management seemed so committed to its guidance. Now I don’t need to have qualms about it.
It’s not just about earnings forecasts
Revisiting my original model and revising the base assumption of ‘underlying’ EBITDA from £225m to £185m changes how much the company can repay on its debt, and therefore how much interest it has to pay as the reality of higher interest rates hits home when its Secured Senior notes fall due in 2026 and 2028. I note that house broker estimates include a recovery in underlying EBITDA to around £200m, but I can’t be that sanguine given that the H2 FY24 underlying EBITDA estimate is now around £90m.
As I stated in the original blog, there is a considerable amount that can happen and that Victoria’s management can do between now and 2026. And the assumption of nil top-line growth (ex-acquisitions) and stable adjusted EBITDA margins is clearly a pessimistic, illustrative assumption that should not be used as a basis for an investment decision. DYOR.
Moderate forecast change can mean major direction change
As can be seen from the tables below, with the higher underlying EBITDA of £225m and assuming £75m per annum redemption of preference equity, Victoria redeems the preference equity before the increase in its interest rate ramps and it starts to reduce the senior debt before its interest cost escalates in 2026. As a result, on these illustrative figures, it is relatively comfortably positioned to grow again on the other side of the economic slowdown, with illustrative interest cover of around 2.7x-3x in FY27-FY28.
With the lower illustrative underlying EBITDA of £185m and assuming £50m per annum redemption of preference equity, Victoria is caught by higher interest rates on the remaining preference equity in late 2025 and has not materially reduced its more traditional debt before the interest rate on that increases too. On these illustrative figures, Victoria looks to exit the economic slowdown with far from comfortable illustrative interest cover of c.2x in FY27-FY28.
On these illustrative figures, a cut in forecasts of less than 15% at the EBITDA level looks to have had a fundamentally greater impact on the prospects of the business.
But the same story gets told for both – you need proper forecasts
It is also interesting to consider what the narratives would be under both scenarios. They would, I suspect, be essentially the same, with management talking about headwinds and actions on margins and analysts anticipating recovery, focusing on EBITDA (still), and pointing to cash generation and debt repayment. Clearly, as investment propositions they are fundamentally different, but it is only by having properly constructed forecasts that investors can spot the difference – many don’t.
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