This week, Steve Johnson, is joined by Alex Shevelev, Senior Analyst with the Forager Australian Shares Fund. They talk about businesses that shrink by comparing two stocks in the travel industry as examples, Webjet and Tourism Holdings.
Hi everyone and welcome I’m Steve Johnson, Chief Investment Officer here at Forager Funds and I’m joined in this week’s video by Alex Shevelev, who works with us on the Australian Fund. Today we’re going to talk about something a little bit wonkish for the people who love getting into the details out there.
And that is analysing businesses that shrink. Unfortunately it happens. It happens because industries go into decline, it happens because of recessions and it happens because of you guessed it, Corona virus. We’re going to talk about two stocks today in the tourism industry as an example. They are Tourism Holdings, a Kiwi listed company and a name probably familiar to most of you, Webjet listed here on the ASX.
Alex, can you give us a quick explanation of what these two companies do?
So Webjet is familiar to a lot of people, there’s two businesses there. One is a business to consumer portal that you may have booked a flight through not recently, but sometime back. And another is a business to business, a more wholesale component of a business around hotel beds.
THL on the other hand is a rental company for caravans. Now what they do is they would purchase those caravans, they would rent them out and eventually sell those. They operate in Australia and New Zealand and in the US.
So they’re both two tourism related businesses. It’ll probably come as no surprise that the revenue line has been hammered at both of them. I’ve got a chart here that shows you the net debt situation for these two companies as at 30 June last year, so prior to COVID hitting. Now Alex if you took a quick look at this chart, which of these two businesses, would you be most concerned about heading into a significant contraction in demand.
Immediately you would look at Webjet and say, well, there’s not much net debt there and there is a lot at THL.
Now you weren’t actually concerned about THL, but you were very concerned about Webjet. We were aggressively buying Tourism Holdings through March and April. We participated in the Webjet capital raising, but didn’t hold that for long. Can you explain why you were not concerned about the one that had a lot of net debt and you were concerned about the one that had a net cash balance sheet?
So let’s take Webjet first. Here we are taking cash in from consumers and we are paying it with some delay to suppliers. Now that means that as the business grows, that’s actually quite good for them. They accumulate more of that cash themselves and the net debt balance looks very attractive as the business starts to shrink though. You’re looking at it going the other way. You’re forced to make payments to suppliers, in this case you’re forced to make some payments of refunds to consumers as well.
So you are stuck in a situation where your working capital, which is the difference between those two numbers starts to unwind, and that is a difficult place to be.
So we’ve got a chart here up on the screen. You can see that Webjet actually owed its suppliers some $200 million more than it was owed by its own customers at 30 June last year.
As the revenue line has shrunk those suppliers obviously wanted their money back and they didn’t have the cash coming in from customers anymore. You see the difference there, more than $150 million of working capital unwound. On the other hand, Alex what’s happened at Tourism Holdings?
So Tourism Holdings has a lot of camp events that they currently hold. Now that is on the balance sheet as a P, P and E, property, plant and equipment, but actually those are reasonably liquid and they’re even more so liquid now because of the attention that’s been put on holidays that people can actually take and the isolation factor that goes with being able to take a camp event holiday.
So there’s a lot of demand for these vehicles, lots of retail demand and that means that THL has actually been able to sell a lot of those vehicles and actually bring cash back from those sales. So unwind the working capital that they had inclusive of that P, P and E.
Yeah and it actually didn’t even require a change of business model at Tourism Holdings. They turn a lot of these assets every year anyway, they buy a lot of new camper vans. They were selling a lot of secondhand ones and it was as simple as just stopping buying them because they needed a smaller fleet. You keep selling the amount you were selling, and as you said, it’s actually been pretty good environment, particularly in the US for selling these assets at good prices.
So if you look at the cash from operations for these two companies, we had the Tourism Holdings result just out this morning, Webjet was probably a month or so ago. But this chart here really shows you how these two businesses have behaved differently over the past 12 months.
That’s right. So you can see Webjet actually consumed $250 million worth of operating cashflow here. And that is the unwind of a working capital we were talking about earlier. On the other hand, THL generated about $50 million worth and that comes from the unwind of some of the working capital position that they had previously held.
And we’re seeing even further progress on that front since the end of the year. Today’s announcement had an even lower net level than the 30 June number.
That’s right and that’s how we get THL from a 200 odd million dollar net debt balance down to something like 75 million dollars over the space of that year. We’re gradually realizing that P, P and E and a sort of working capital in this case and paying down that debt.
So that’s why the company that had a net cash balance sheet has had to do a massively dilutive capital raising while the company that had a fairly significant amount of net debt this time last year has not had to raise a cent.
Some of these businesses with networking capital look absolutely wonderful in the upswings. They generate lots of cash flow and no one likes good cash conversion more than us, but it’s something to watch very closely in a downturn. Hope you’ve enjoyed this little video. Don’t forget to follow us on YouTube or any of your social media channels and get in touch if you’ve got any questions. Thanks for watching.
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