With the Australian share market rallying strongly in April off the 25 March low, there has been a spate of capital raisings by cash-strapped companies looking to reduce debt and/or ‘pay the bills’. One of those is travel retailer, Flight Centre (ASX:FLT). In this 2-part blog, I outline our assessment of the business in the face of COVID-19 risks and the likelihood of negative earnings for the foreseeable future.

The raisings have been done with a combination of placements to new and existing shareholders as well as rights issues, and in general have been heavily oversubscribed as new and existing investors alike view the steep discounts as attractive to invest in the business.

Many of these businesses are facing significant disruption or have a vastly different outlook compared to Pre-COVID-19. The list so far is wide-ranging, and includes companies like Cochlear, Oil Search, IDP Education, Webjet, QBE, Invocare – with many more expected over the following months.

At Montgomery, the team have assessed almost every opportunity and looked to participate (and have participated) in a number of these raisings. However, given the uncertain outlook for many of these businesses and the lack of earnings guidance, how are investors looking at valuing these businesses?

A quick look at Flight Centre’s capital raising

Flight Centre operates as a retail travel agency operating under a number of brands, with a global store network and a significant online presence. FLT predominantly generates revenue through selling travel packages for Leisure and Corporate purposes, based on a percentage of Total Transaction Value or “TTV”.

FLT’s share price peaked in August 2018 at around $69.36 per share, when the company generated a record underlying profit of $385 million for the 2018 financial year.

However, with all the restrictions on travel as a result of COVID-19, it is no surprise the company’s share price has been under severe pressure. The company entered into a Trading Halt on 19 March, as it looked to raise money to shore up its balance sheet to weather the downturn.

FLT – the need for a capital raising

Prior to FLT’s capital raise, the company had a positive working capital position of roughly $700 million – which assumes no bad debtors on the company’s Receivables (FLT management assesses this risk at around 4-5 per cent as at early April). Total available liquidity was approximately $1.4 billion, but this is largely offset by net creditor liabilities of around $700 million and also excludes bank borrowings of $215 million as at 31 December – i.e., the often ignored liabilities on the balance sheet. FLT’s pre-existing working capital position is laid out in its presentation, below.

Source: Company filings

The company had a cash-burn rate of $227 million per month, which gave FLT less than 3 months of headroom before burning into available debt funding lines of $100 million (2 weeks), the drawdown of which the banks would likely have been opposed to without a remediation plan given the uncertainty around the immediate outlook.

Capital raising details

Prior to the capital raising, the FLT share price closed at $9.91 per share on 19 March.

The company launched a placement and rights issue totalling around $700 million at $7.20 per share, with the issuance of an additional 97 million shares. The company effectively doubled its share count from 101.1 million shares to 198.4 million, assuming full take-up of the retail entitlement offer.

Net proceeds were approximately $679 million.

In conjunction with the placement, the company obtained temporary waivers on debt facilities, with an additional $200 million available for drawdown although subject to minimum liquidity requirements.

The raising, along with additional funding lines has given FLT around $1.6 billion of total liquidity, or $1.4 billion liquidity not subject to constraints on drawdown, after repairing and unwinding the various balance sheet items (assuming no bad corporate debtors).

What will FLT do with all the additional cash?

For a start, FLT management will look to reduce its store footprint and cash operating expenses.

Pre-COVID-19, $1.4 billion would have been enough for around 6 months of expenses at the current run-rate. Obviously, the revised reality is that these travel businesses won’t go from 0 to 100 overnight given travel restrictions will only be unwound gradually. As a result, revenue will be slower to recover and it will take time for FLT to break-even, especially on its current cost base.

So, as part of the rescue package, FLT is reducing its store and staff footprint by approximately half over the next 2.5 months, while minimising capex and discretionary expenses. This is expected to reduce the monthly cost profile from $227 million to $65 million by end July. The cost to implement (including redundancies, breaking leases etc) is expected to be $210 million, with total costs including net operating losses during the transition period of $155 million i.e. total costs to implement to July are a total of approximately $365 million.

Source: Company filings

After implementing all cost reductions, FLT is left with around $1 billion of liquidity from August, excluding the increase in available banking facilities subject to liquidity covenants of $200 million. However, to be conservative, it would be appropriate to apply a reduction in the collection of at least some retail and corporate debtors. As a very rough sensitivity – assuming 10 per cent on total working capital assets figure (more than double FLT management expectations) would suggest up to $100 million in potential losses, leaving FLT with $900 million of liquidity.

At a cash-burn rate of around $65 million, this would fund FLT’s operating requirements well into 2021 at minimal revenues before requiring a material pick-up in business. While this seems like a significant buffer given tentative signalling of easing some domestic restrictions, with the uncertainty around how long travel restrictions would be in place it appears FLT has “over-raised” to give it sufficient buffer for a protracted downturn on travel.

In part 2, I will talk about assessing the potential opportunity of FLT shares – bought on the discounted rights and placement price, as well as what the current market price may be suggesting.

Michael Whelan

Joseph - without pre-empting what is coming in part 2, the big issue for the travel companies is those client liabilities, largely being holidays and travel that people have paid for....and which they can't now take.....and they may want to be refunded.....

Joseph Kim

Hi Michael, If you look at FLT's presentation slide above, it outlines $1,018m in client creditor liabilities, which I would suggest accounts for the issue you have highlighted. Thanks

Dan Callery

Great post, when is part 2 coming?

Michael Whelan

Yes, it does Joseph, and which I saw. I mentioned it b/c you didn't mention it in your piece.....apart from a box and an arrow which the unobservant might miss or overlook......and I didn't want to pre-empt that it may be mentioned in your Part 2 analysis. That is a potential 'real-time demand' on FLT's cash - think of it, in effect, as money held in trust for people who've booked flights, accommodation, etc. If people want their money back, etc then that's where the problem lies. As you say, this is, in toto, a rescue package for FLT. Maybe we won't see FLT shopfronts around the Melbourne CBD (and elsewhere?) within 100m of one another any more?

Ganesh Parajuli

Quite insightful. Do you think FLT smartly handling customer complaints and anger over cancellation fees? Over short term at least; i could see the reputation and litigation risk and its negative reflection on Share Price.

Joseph Kim

Thanks Dan - we will post it up in the next couple of days. Michael - you're right, it was very easy to miss - unfortunately the resolution wasn't as clear as hoped. re: shopfronts - they have flagged consolidation of shops as part of their cost reduction strategy. Thanks Ganesh. Re: customer complaints , I am in no position to comment specifically but would note the significant disruption to travel-related companies and their supply chains will understandably lead to longer times for resolutions.

Alan Caster

Good analysis however, Isn’t there a problem that we are going into a recession that will be the worst since 1930. Which will mean that there will be less travel both recreationally and business. In addition their distribution system has been substantially reduced so the revenues that they previously made will not be achievable. The founding directors were right in not putting in more money!

Malcolm Middleton

Interesting article, Thanks Joseph, would be interested in you doing a similar appraisal of Webjet having also just completed a capitol raise

Joseph Kim

Sorry Malcolm, I haven’t had a chance to look at Webjet in the same detail.