We thought you might be interested in a question that one of our consultants asked just the other day:
“How would our stocks fare if EBITDA halved (because of COVID19)? What would be the immediate impact? In particular, would they still be able to cover their debt repayments? Would they be in breach of their covenants?”
Perfectly reasonable questions given our preference for growth albeit at what we determine a reasonable price.
Before we address the question, we thought it was worth sharing a top down view of the current portfolio. One of the basic planks of our process is high EPS growth (at least 15% year on year) and a valuation threshold of 1.5x PEG.
If we assume earnings halved this year but were subsequently regained in FY2021, our portfolio’s growth and valuation profile would still fulfil our criteria:
| Aubrey European Strategy | FY2020 | FY2021 |
| Average PE | 18.5x | 15.7x |
| Average EPS Growth | 16.1% | 33.0% |
| Average PEG | 1.1x | 0.5x |
Source, Aubrey Capital Management as at 31 March 2020
This demonstrates our portfolio is made up of holdings that have high earnings growth potential on very attractive valuation levels. Neither are they highly geared:
| Aubrey European Strategy | FY2020 |
| Average Net Debt*/Equity | 41% |
| Average Net Debt*/EBITDA | 2.3x |
Source, Aubrey Capital Management as at 31 March 2020
*Net Debt = Long term debt + Short term debt – cash
From a bottom-up perspective, we only have five stocks with net debt to equity greater than 70% (excluding real estate). Their Net Debt/EBITDA and Net Debt/Equity profiles are as follows:
| Holdings | Net Debt/EBITDA | Net Debt/Equity |
| Tokmanni* | 6.0x | 206.0% |
| SIKA** | 2.9x | 107.9% |
| Essity | 2.6x | 77.2% |
| Beijer | 2.7x | 74.0% |
| Kering | 1.7x | 73.1% |
Source, Aubrey Capital Management as at 31 March 2020
*Tokmanni’s net debt to equity has very recently changed due to the application of IFRS 16 which put their store operating leases on the balance sheet.
**Sika’s debt is temporarily elevated above 100% due to the purchase of its own shares from St Gobain following the failed takeover attempt.
In addition, we also have four property companies that naturally have a higher Net Debt/Equity given the common use of leverage in the industry.
| Holdings | Net Debt/EBITDA | Net Debt/Equity |
| S IMMO | 15.9x | 118.6% |
| PPHE Hotel Group* | 4.6x | 109.3% |
| Aroundtown | 12.9x | 58.4% |
| Unite Group | 9.9x | 47.8% |
Source, Aubrey Capital Management as at 31 March 2020
*It is important to note that PPHE Hotel Group recognises its properties on the balance sheet at historic cost. Consequently, its assets are understated relative to fair value hence a higher recorded gearing.
We have spoken to 80% of the companies in our portfolio and are due to speak to the remainder shortly. Of the companies we have spoken to, if EBITDA were to halve, our companies would still be able to meet covenants given that one of the basic planks of our process is strong cash flow generation (at least 15% cashflow return on assets).
In summary, 24 out of 35 of our holdings have a net debt to equity less than 50%, 7 have a net debt to equity between 50% and 80% and only 4 (2 of which are in the property sector) greater than 100% (listed above).
While visibility is limited on how long the current environment will last, having spoken to company managements, further cost reduction plans, in terms of raw materials and other operating costs as well as capital expenditure, can be expected to preserve company values and hence the capital in our portfolio.
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Disclaimer: the views represented in this article are Aubrey’s own and do not reflect company guidance. This document has been issued by Aubrey Capital Management Limited which is authorised and regulated in the UK by the Financial Conduct Authority and is registered as an Investment Adviser with the US Securities & Exchange Commission. You should be aware that the regulatory regime applicable in the UK may well be different in your home jurisdiction. This document has been prepared solely for the intended recipient for information purposes and is not a solicitation, or an offer to buy or sell any security. The information on which the document is based has been obtained from sources that we believe to be reliable, and in good faith, but we have not independently verified such information and no representation or warranty, express or implied, is made as to their accuracy. All expressions of opinion are subject to change without notice. Any comments expressed in this presentation should not be taken as a recommendation or advice. Please note that the prices of shares and the income from them can fall as well as rise and you may not get back the amount originally invested. This can be as a result of market movements and of variations in the exchange rates between currencies. Past performance is not a guide to future returns and may not be repeated. Aubrey Capital Management Limited accepts no liability or responsibility whatsoever for any consequential loss of any kind arising out of the use of this document or any part of its contents. This document does not in any way constitute investment advice or an offer or invitation to deal in securities. Recipients should always seek the advice of a qualified investment professional before making any investment decisions.