Casino survives the Bear trap, yet again!

Casino’s parent Rallye has announced the commencement of a debt re-profiling process under the protection of French courts. Casino is not included in this process (there is no cross default provision). In the short-term, Casino should get a breather, as Rallye would freeze creditor payments (hence, does not need dividend payments from its subsidiary). Even in the mid/long-term, Casino should be better placed relatively (we discuss some scenarios below). Moreover, we repose our faith in Casino’s business model/FCF generation prospects in France.

An interesting duel is going on since early 2018. On one side is the mathematician cum retail kingpin Jean Charles Naouri, who is the CEO plus controlling shareholder of Groupe Casino and its parent holdings (Rallye, Foncière Euris, Finatis and Euris). On the other side is a set of deep-pocketed hedge funds, which are extremely bearish on the future of Mr Nouri’s retail empire.

And, the bone of contention has been the high leverage at Casino and its parent Rallye (owns 51.7% shares of the retailer). Note that Rallye relies heavily on dividends received from Casino to repay its financial obligations/standalone debt. However, numerous analysts (and a wide section of the investor community) have been raising questions on the health of Casino’s free cash flow in France (before dividend payments and financial expenses) – would it be enough for Casino to continue paying these dividends? As a reminder, Casino owns a 100% stake in France but is just a minority shareholder in the healthier Brazil/LatAm region).

Moreover, these bears have been betting big on Rallye to default on standalone debt, which is classified largely under four categories – bonds, commercial paper, bank loans and lines of credit. While the first two types do not require any asset pledge, the latter require the parent entity to submit Casino shares (owned by it) as collateral. To make the matter worse, almost all Casino shares have already been pledged by Rallye – as the number of shares pledged is directly impacted by Casino’s stock price variations. In other words, Rallye would be in a tricky sport/not be able to pledge any more shares, if bears continue to bash Casino.

The battle of dominance

In the battle of 2018, bears dominated during the first eight months (thrashed Casino c.50%, bringing it down to two-decade lows). However, Mr Nouri proved a tough nut to crack – he swiftly announced an aggressive de-leveraging plan, clubbed with healthy FCF performance on the domestic front. By early March 2019, the stock price had recovered almost all the ground ceded in 2018.

Come mid-March 2019 and Casino announced the FY results. While management fulfilled its promise of net debt reduction, bears smelled the blood again, as questions were raised on the strength of recurring French FCF (excluding the cash inflows from the asset disposal plan). After reassessing Casino’s French fundamentals and a subsequent interaction with the CFO, David Lubek, we took a positive stance with a rider that bears might remain dominant in the short-term (especially in H1 2019) – refer to our report dated 25 March 2019 for more details. And they wasted no time in tanking Casino’s stock price, once again ringing the alarm bells for Mr Naouri.

The game changer

By 23 May 2019, bears looked all set for the final assault. This is when the trading of Rallye and its holding companies was suspended by the stock exchange. Casino also followed in the footsteps, perhaps at the company’s request.

Later in the evening, Casino’s parent Rallye announced the commencement of a debt re-profiling process under the protection of the French courts. The safeguard proceedings cover Rallye, its subsidiaries (Cobivia and HMB), as well as the three parent companies (Foncière Euris, Finatis and Euris). In other words, Rallye’s listed subsidiaries Casino and Go Sport would not be included in this process – there is no cross default provision in this agreement. Under the safeguard proceedings, management has been granted six months to re-profile its financial debt, which stood at €3.2bn at the end of 2018. Normally, proceedings last up to 18 months, and the outstanding debt could be rescheduled by the protected company over a period of ten years.

Since this announcement, while Rallye’s stock price has collapsed c.60%, its subsidiary Casino has rebounded c.12%. In our opinion, this new development is an overall positive for Casino, both in the short as well as the long-term.

Short-term:

Since Rallye would freeze all creditor payments over the next 6-18 months (under the debt re-profiling plan), Casino could use this opportunity to trim the dividend payments to its parent – the reduction might be more than 50%. We believe the retailer’s store estate is already well invested and the current capex guidance is enough to meet e-com expansion plus other plans. Hence, these savings (c.€350m dividend paid per annum) could be used to repay Casino’s debt or for any other activity like share buy-backs. A relief from dividend payments is also likely to alleviate the pressure on Casino’s French performance/FCF generation in the short-term (remember, it is one of the key concerns raised by pessimists).

Long-term:

If Rallye fails to set its house in order within the time permitted by the French courts, all options should be on table – as debt rescheduling without improved cash flows will provide a breather to Rallye only in the short-term. This includes getting a new partner on board with a partial stake sale to an outsider (e.g. Amazon, which will get accelerated access to subsidiary Casino’s physical stores in France plus it already has a tie-up with cash cow Monoprix). Fresh equity infusion by a deep-pocketed giant is also likely to improve Rallye’s leverage statistics and simultaneously assuage investor concerns regarding debt default. In such a case, while Mr Naouri’s shareholding in Casino might come below 50%, he might still be able to retain control though voting rights – remember, Rallye commands a 51.7% stake and 63.0% of voting rights at present.

The alternative option involves creditors or banks being forced to take a hair-cut on outstanding debt or to exercise a debt to equity swap. In both scenarios, Jean Charles Naouri is likely to cede control of the crown jewel Casino. With the parent Rallye crumbling under its own debt, the pressure on Casino is likely to reduce (lesser burden to feed the parent holding), as a result. Indeed, it is a positive development for Casino shareholders – minority perspective.

Casino – nothing wrong with operations

Casino has been reducing the French net debt gradually (-65% vs. 2014). Management is also on the right path – in the process of disposing additional non-core assets worth €1bn (taking the total sale to €2.5bn) to make the balance sheet healthier. We continue to expect that Casino’s pain-points will start fizzing-out from H2 FY19. The first positive trigger is likely to be gross debt reduction by almost €1.2bn through to coming September (includes redemption of bonds worth €675m which are not likely to be refinanced). And lower financial expense would be a by-product in the subsequent quarters. Net net, we reiterate that there is nothing wrong with Casino’s French fundamentals, and management should be able to achieve its guidance, once again.

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