So wow, -30% in 3 days...
What do we know:
Cash flow from Operations (OCF)
Gross OCF (customer receipts less payments) was negative over the full year, and this has contributed a $78.3m increase in overall
net debt ($A682.3m). I don't find the net debt figure a particularly helpful number (although it impacts the gearing ratio), and I prefer to think of the
gross debt figures in local currency (AUD and GBP) terms. The AUD 90m and GBP 375m
bills of exchange long term debt facilities (maturing in May 18 & March 19) are now
fully drawn, so future negative OCF amounts cannot be funded by these facilities in the absence of another refinancing event.
SGH however has $82.5m in cash (30 June 16), which it can use as working capital. It also has a A$5.8m bank overdraft facility (AUD 4m and GBP 1m), which appears to be available/undrawn as at 30 June 2016 (refer to p7 and p67 of AR).
So with $82.5m in cash + $5.8m overdraft facility (potentially) available to fund ongoing business operations,
what do we expect gross/net OCF to be in FY 17, and more importantly do we expect it to be positive or negative?
Well in FY 16 we know that there were $20.7m of non-recurring expenses included in GOCF.
GOCF - FY16 ($78.3m)
GOCF -FY16 (normalised) ($57.6m)
Non-recurring cash expenses $20.7m
GOCF non-recurring expenses included costs from redundancies, office closures and UK rationalisations, which resulted from implementation of the UK Performance Improvement Plan (PIP), which is still underway.
NOCF also included significant non-recurring consulting costs, material facility amendment fees and higher interest margins.
NOCF - FY 16 ($104.2m)
Can we expect more non-recurring expenses in FY 17?
IMO most of the required non-recurring expenses have been incurred in FY 16, however some may still remain in FY 17. E.g. I understand some remaining UK offices are slated to be closed in FY 17 and any resulting one-off charges will impact on GOCF.
Net interest (a recurring NOCF factor) is another drain on cash that also needs to be factored in. For FY 16 this was $34.9m, however was to some degree offset by a net tax refund of $23.2m.
The above discussion has to this point ignored forward looking GOCF (customer receipts less payments). The UK PIP is clearly geared towards getting this to a positive number as soon as possible by driving increases in revenue receipts and reduction in cash costs. I sense a similar plan is being rolled out across the Australian business as well, with mention of an underperforming Conveyancing (GL) practice that has prompted a strategic review. This is a negligible part of the Australian business in any case, however suffice to say management are focussed on what they need to be doing.
With SGH always being a turnaround story, it is clear after removing the effect of the non-recurring expenses, there has been a substantial turnaround in cash flow from H1 to H2, demonstrating IMO success in the turnaround initiatives implemented to date.
GOCF - 1H 16 (normalised) ($58.1m)
GOCF -2H 16 (normalised) $0.5m
Change $58.6m
Whilst some may begrudge $0.5m as an immaterial cash accretive number, it reflects a +$50m turnaround in cash flow from 1H to 2H. This reflects benefits derived from the UK PIP, which as mentioned is still underway and expected to reap more improvements over the next 12-18m. This is good thing, not a -30% bad thing.
What do the FY 16 results tell us about improvements in the underlying 3 businesses?
SGL Australia (SGLA)
SGLA revenues increased 8.1% YoY.
- The Personal Injury Law (PIL) practice accounted for 77% of SGLA revenues, and increased 6.6% YoY. This practice has a much higher operating margin (revenue/EBITDAW normalised) of 17.1% (20.9% FY 15) and therefore accounts for the majority of the EBITDAW (normalised) balance of $35.9m.
- The General Law (GL) practice accounts for the remaining 23% of SGLA revenues, and increased 13.4% YoY. This practice has a much lower operating margin of 1.1% (3.0% FY 15).
- EBITDAW was however impacted by higher costs for labour, IT, audit, legal fees and other corporate costs.
-
Non-recurring expenses totalled $43.6m in FY 16.
SGL UK
We are advised that implementation of UK PIP is beginning to produce the desired benefits.
-
Improvement in operating revenue on a
substantially lower cost base has improved performance from the 1H normalised EBITDAW loss. FY 16 normalised EBITDAW was a loss of GBP 0.7m. Unfortunately the FY 16 Investor Presentation did not provide a H1 to H2 comparison
-
Non-recurring expenses totalled GBP 14.9m in FY 16.
SGS
- Claims (incl. NIHL) revenue increased 16.4% HoH (in GBP terms). This is echoed in the Investor Presentation "consistent quarterly improvements in claims handling and resolution activity... SGS Motor... is also... delivering new client opportunities in PIL cases to Claims."
- SGS Motor H2 revenue declined due to the loss of the Swinton contract noting the immaterial impact on the EBITDAW line.
- NIHL resolution and settlements - management has not advised of any change in the probability of success, and case acquisition costs have already been expensed. Is it reasonable to assume some progress on this over the next 12 months? I think so.
Debt
Semi-annual debt amortisation commences from June 2017 (we don't know what the amortisation schedule looks like), and the first LT debt facility matures in May 2018.
May 2018 (A$480m)
AUD 45m
GBP 217m
March 2019 (A$360m)
AUD 45m
GBP 157.5m
Whilst these facilities have been converted to term loans, with the presumption of full repayment on maturity, I don't think any reasonable person expects that to be the case here. The Company has target gearing of 30-40% (40% = A$122 based on 30 June 16 Equity $305.1), and if it can reduce some debt prior to the maturities and demonstrate restored earnings and cash flow I think the bank's would be willing to re-finance the facilities for the appropriate amendment fee of course
Gearing was 45% and 222% as at 30 June 15 and 16 respectfully. The latter figure has obviously been inflated by the huge reduction in equity following the goodwill impairment, and we need to see a material reduction in debt and/or an increase in equity (CR) to get the gearing back down to target levels. With that said, the amended SFA reset the covenants (presumably including gearing) providing the Company with sufficient headroom as it executes its PIP. Any other details relating to the amended SFA are opaque and I'd prefer not to speculate further.
However, I see it this way. The Company has demonstrated improvements from H1 to H2 on a normalised basis. Yes GOCF and NOCF was negative, but did we really expect it to be positive with all of the one-off expenses it needed to incur to reorganise the business.
There were a lot of things I wanted to say in this post and I probably haven't said them all. However the point was to put some of the FY 16 numbers into perspective and underline that SGH is a going concern (IMO), at least for the remainder of the FY.
This post was really an exercise to get my thoughts out of my head, so I welcome any comments or criticism.
