Growth from Mexico and Spain, combined with ongoing operational efficiencies, continues to offset pressure from the Argentine division (23% of Q219 revenues). Codere (MC:CDRE) is maintaining FY19 EBITDA guidance with positive net cash flow for the year. The net debt/LTM EBITDA ratio is 2.7x and the company is successfully navigating the Argentina uncertainty. We maintain our underlying EBITDA forecast for FY19, although we are lowering our FY20 EBITDA estimate by 7.1% to €368.4m as we now expect Argentina to continue contracting next year. The stock is very illiquid and trades at 4.1x EV/EBITDA for FY19e, which is at a deep discount to peers.
Maintaining FY19 EBITDA guidance
Q219 revenue declined by 5.7% y-o-y to €354.7m and H119 revenues decreased by 6.2% to €712.4m. In constant currency, Argentina grew by 25% in H119 but declined by €71.9m due to the depreciation of the Argentine peso. Nonetheless, growth from other regions (notably Spain and Mexico), combined with ongoing cost efficiencies, mean that Codere is maintaining its FY19 EBITDA guidance of €280–290m (pre IFRS 16 changes). We are forecasting Argentine revenues to decline by 28.5% in FY19 and 12% in FY20 (to 17% of revenues) and are lowering our group FY20 revenue by 8.5% and EBITDA by 7.1%.
A history of navigating Argentine fluctuations
At the end of Q219, Codere reported net debt of €1,090m, which equates to a net debt/adjusted LTM EBITDA of 3.0x (or 2.7x before IFRS 16 adjustments). This is well within banking covenants and Codere has sufficient funds to service the debt, with comfortable interest service ratios. We expect the company to refinance the senior notes in the near term, although this is not helped by Moody’s and S&P’s recent negative rating changes (to B3 and CreditWatch Negative respectively). In line with guidance, we continue to forecast net cash flow this year and note that Codere has a long history of managing Argentine FX and inflation fluctuations, including capital controls.
Valuation: Illiquid, at deep discount for EV/EBITDA
As a result of a restrictive shareholders’ agreement, Codere’s stock is highly illiquid and trades at 4.1x EV/EBITDA and 13.1x P/E for FY20e (a deep discount to peers on an EV/EBITDA basis). Catalysts include stabilisation in Argentina, growth in Mexico, demonstrable net cash flow, successful debt refinancing and a resolution of the complex shareholders’ agreement (which includes a possible share placing).
Business description
Codere is an international gaming company that manages c 57,000 gaming machines, 30,000 bingo seats and 7,600 sports betting terminals across Latin America, Spain and Italy. It was founded in 1980, listed in 2007 and completed a successful debt for equity swap in 2016.
Results summary
Revenue: Argentine currency devaluation led to a 6.2% revenue decline
Q219 revenue declined by 5.7% y-o-y to €354.7m and H119 revenues decreased by 6.2% to €712.4m. Growth across Mexico, Online, Spain, Italy and Uruguay was offset by a €71.9m decline in Argentina in H1 (€160.7m in H119 vs €232.6m in H118), due to the depreciation of Argentine peso against the euro.
In terms of gaming capacity, the total number of slots increased 0.8% to 56,589 in H119 driven by growth in Mexico, Spain and Uruguay more than offsetting the reduction in Italy, Colombia and Panama. In terms of venues, gaming halls increased from 145 to 148, and bars decreased from 9,971 to 9,864 in H119.
EBITDA: Operating efficiencies drive margin increase
Q219 adjusted EBITDA (post IFRS 16) was €88.0m with a 24.8% margin vs €86.5m in Q218. H119 adjusted EBITDA was €173.9m (24.4% margin) and pre-IFRS 16 H119 adjusted EBITDA was €138.3m vs €132.9m in H118. The improvement in EBITDA margin was due to sustained operational efficiencies, which fully offset gaming tax increases and the loss in relative weight of the high-margin Argentinean operation.
As we detail further below, our underlying pre-IFRS EBITDA estimate remains broadly unchanged (although our post IFRS EBITDA is 3.5% lower, purely due to a slight adjustment to our IFRS 16 accounting assumptions). On the back of an expected 12% decline in Argentine revenues for FY20 due to the recent further peso devaluation, we are lowering our group FY20 adjusted EBITDA by 7.1% to €368.4m.
Net debt/LTM EBITDA of 2.7x: Credit rating agencies turn negative
At H119, Codere reported net debt of €1,090m, which equates to a net debt/adjusted LTM EBITDA of 3.0x (or 2.7x before IFRS 16 adjustments). This is well within banking covenants (based on pre IFRS 16) and Codere has sufficient funds to service the debt, with comfortable interest service ratios. Within this amount, Codere had €80.9m cash and €143.7m liquidity (including liquidity from the credit facility). This compares to €81.8m and €159.7m at FY18.
We expect the company to refinance the €766m senior notes in the near term and also note that licence renewals are due in Argentina and Italy in the years 2021–24 (c €60-80m). The refinancing terms may be affected by Moody’s and S&P’s recent ratings and outlook changes (see below). In line with guidance, we continue to forecast net cash flow this year and note that Codere has a long history of managing Argentine FX and inflation fluctuations, including capital controls.
Country analysis
Due to the devaluation of the Argentine peso, Argentine revenues have been steadily falling over the past two years and now represent 23% of the group total. To counterbalance the decline, Codere has been channelling investment into other growth markets (notably Spain and Mexico) and, as a result, for Q219, Mexico comprised 24% of total revenues and 44% of adjusted EBITDA.
We highlight the significant developments in the first half below. For further information on the country dynamics, please see our July Initiation.
Mexico: New capacity to drive revenues
Q219 revenues (excluding online) in Mexico increased by 5.3% to €84.2m and by 7.2% in H119 to €167.8m. This was despite a more competitive environment and was driven by growth of 7.7% in the average number of slots, as well as a 6.2% depreciation of the euro against the Mexican peso in H119.
Q219 adjusted EBITDA was €40.4m (€31.9m pre IFRS 16), which compares to €33.2m in Q218. For H119, this equated to €78.6m (or €61.6m pre IFRS 16). The adjusted EBITDA margin increased from 42.0% in H118 to 46.9% in H119, due to continued cost reductions, and the positive impact of the acquisition of machines in H218.
Codere has opened four additional halls vs the prior year and this should help to drive growth going forward. We are forecasting Mexican revenues of €344.4m for FY19, with growth of 8% in FY20 to €371.9m, with an EBITDA margin of 52.8%.
Argentina: 79.6% devaluation of peso in H119
In constant currency, Argentine revenues increased by 24.8% in the first half to €160.7m and gross win per slot per day in local currency grew by 22.1%. This was well below the average inflation rate of 54.2% during H119.
Due to the 79.6% devaluation of the Argentine peso, H119 revenues declined by 30.9% to €160.7m and Q219 revenues declined by 27.2% to €80.0m. Revenues were also affected by the new tax on prizes (3%) effective since February. Q219 adjusted EBITDA was €18.7m (or €17.3m pre-IFRS 16). H119 adjusted EBITDA decreased by 35.5% to €37.0m, as a result of the devaluation of the Argentine peso and the introduction of the tax on prizes, partially offset by efficiencies implemented in the year. The adjusted EBITDA margin was 23.0% in H119, vs 24.6% in the prior year, due to the increase of gaming taxes.
In August 2019, there was another significant devaluation of the peso (as a result of a probable Peronist government) and the peso currently trades at 62 ARS/€ vs 50 ARS/€ in August and 42 ARS/€ at the beginning of the year. The government has also recently imposed capital controls in Argentina, which will not impact Codere materially in 2019 as it has already transferred the majority of Argentine cash (73%) back to Spain. We note that Codere has a long history of managing Argentine FX and inflation fluctuations, including capital controls.
Spain: Growing profitability due to cost efficiencies
H119 Spanish revenue (excluding online) increased by 5.4% to €96.1m, driven by growing revenues in retail sports betting and the slot route businesses, with 22.4% and 6.3% more installed units respectively and the progressive maturity of the sports betting capacity installed. This was offset by a 2.4% decrease in route slot unit yields (mainly driven by the increase in the number of units, especially in arcades). Q219 revenues increased by 2.6% to €47.5m, despite the difficult sports betting comparisons in Q218 (FIFA World Cup).
H119 adjusted EBITDA grew 18.7% to €22.5m with a margin of 23.4% vs 20.8%, due to continued cost efficiencies. Pre IFRS 16, H119 EBITDA was €19.1m (vs €15.4m in the prior year).
We forecast Spanish revenues of €203.9m for FY19 and further growth of 15% in FY20, helped by a greater number of sporting competitions in 2020 (notably Euro 2020). Note that from FY19, online is reported separately and is not included in the Spanish division.
Italy: Improving yields, but higher taxes affect margins
H119 revenues increased by 2.9% to €171.6m, due to the significant improvement on machine yields (21.5%), as well as the higher gaming tax (that increases the share Codere keeps from machines in bars), offsetting the reduction in capacity defined by the regulator in 2018 (11.3%). Increased fees to units connected to the network also contributed positively. Q219 revenue increased by 4.5% to €85.1m.
H119 adjusted EBITDA was €12.1m, 25.7% lower than the prior period, due to the reduction in capacity and the higher gaming taxes. Pre IFRS EBITDA for H119 was €8.3m.
We are forecasting revenues of €347.2m in FY19, growing at 2% thereafter with an EBITDA margin of 8.7% in FY19 and FY20.
Other operations (Panama, Uruguay, Colombia and Online)
H119 revenues increased by 4.4% to €116.2m. Online increased by 47.5% to €29.9m, due to increasing momentum in Spain and Mexico and despite difficult comparisons from the prior year (FIFA World Cup). Uruguay revenues increase by 6.3% to €37.3m after a strong performance in HRU and Carrasco Nobile, although Panama and Colombia declined by 13.8% (€38.3m) and 6.8% (€10.8m) due to the closure of non-performing casinos.
Adjusted EBITDA increased by 19.2% to €28.7m and pre IFRS 16 EBITDA increased by 38.0% to €21.2m, with online increasing €4.0m to €2.4m, Uruguay increasing €2.0m to €10.0m and Colombia up €1.9m to €3.1m.
We forecast other operations revenues of €239.1m in FY19 and €255.6m in FY20, with an EBITDA margin of 24.7% in FY19 and 23.9% in FY20 (as the lower margin online steadily becomes a larger percentage of the total).
Estimate changes
FY19 EBITDA maintained; FY20 EBITDA lowered by 7.7%
We have lowered our FY19 revenue forecast by 3.5% to €1,426m, on the back of the devaluation of the peso, and for FY20 we are now assuming that Argentine revenues will decline a further 12% in FY20 (to 17% of revenues), due to the recent further peso devaluation. As a result, we have lowered our group FY20 revenue forecast by 8.5% to €1,472.8m.
Our FY19 pre IFRS 16 EBITDA forecast is €282.4m, which remains towards the bottom end of management guidance (€280–290m). Our headline EBITDA forecast is €352.4m vs €361.9m previously as we have slightly revised the IFRS 16 adjustments to €70m rather than €80m previously. Largely due to lower than expected Argentine revenues, our FY20 EBITDA is lowered by 7.1% to €368.4m.
Our FY19 EPS forecast declines by 37.5%, which is a combination of a number of factors: a revised IFRS 16 impact on operating costs (€70m vs €80m) and slightly higher depreciation and net finance charges. The FY20 EPS forecast decline is largely due to a lower EBITDA forecast for the group.
Net debt: Rating changes may impact refinancing
As shown in Exhibit 4 below, at H119, Codere reported net debt of €1,090m, which equates to a net debt/adjusted LTM EBITDA of 3.0x (or 2.7x before IFRS 16 adjustments, which is key for the covenants). Codere reported total financial debt of €871.7m at H119, of which €766.3m was from senior notes, which we expect to be refinanced in due course. Codere still expects to generate positive net cash in FY19, which is in line with our forecast of a €5.9m net cash flow in FY19.
On the back of the Argentine macroeconomic trends, Moody’s has downgraded Codere’s credit rating from B2 to B3, while maintaining the outlook as stable. This is despite the fact that Codere has maintained its FY19 EBITDA guidance. At the same time, S&P has put Codere on CreditWatch Negative to evaluate the company’s ability to refinance its senior notes in the context of the new political scenario.
