Analysis: Fives 2025 SSNs Rise After Q3 Results, Strong Order Intake, Backlog; Lack of Near-Term Triggers Gives Fives Time to Delever Before Refinancing; Inflation Eroding Margins, Unpredictable Working Capital Among Risks

Relevant Items:
Fives Projected, Historical Financials (Excel Download)
Q3’22 Presentation
Q3’22 Report
FY’21 Report
2025 Fixed and Floating Notes OM
Q2’22 Transcript French industrial group Fives’ bonds rose by about 3-4 points since it reported strong third-quarter results on Nov. 18. The group’s €325 million 5% senior secured notes, or SSNs, due June 2025 are quoted at 72.8 today, Nov. 22, yielding 18.9% as according to Solve Advisors, while the €275 million floating rate SSNs due June 2025 at 72.5, yielding 18.4%.

In the third quarter ended Sept. 30, the group generated €50.5 million of levered free cash flow reflecting the sales ramp-up from the backlog and working capital reversals. The company regained full access to the €115 million RCF by reducing leverage. This helped improve liquidity. Total net leverage decreased to 6.7x as of Sept. 30, from 7.8x in the prior quarter thanks to an increase in the last-12-months’ EBITDA to €118.5 million and a decline in gross debt after amortization payments.

The performance in the quarter and the solid order intake and backlog support Fives refinancing prospects in our view. The lack of near-term triggers gives Fives time to deleverage to facilitate a refinancing toward the end of 2024, when the RCF matures. We note that despite a recent leverage reduction, the outstanding notes were marketed at a net leverage of 4.1x in 2018. The group said it expects FY’22 EBITDA to exceed pre-Covid levels of about €120 million and in 2023 it expects to achieve an all time high EBITDA, above €140 million.

Fives enjoys a record high backlog of €2.5 billion as of Sept. 30, which provides revenue visibility over the next 18 to 24 months and could shield the group from demand slowdown in a recessionary environment. The backlog increase is attributable to supply chain disruptions, which did not allow the group to execute the jobs at normal pace, and a strong order intake. The backlog is partly inflated by two jumbo contracts totaling €400 million that Fives signed in the process technologies operating segment in the first quarter. Management said that even in 2020 during the heights of the pandemic no contracts were canceled and there are penalties for customers canceling orders, suggesting a high likelihood that the backlog will convert into revenue.

In 2021 and first nine months of 2022 Fives managed to hold onto its pre-pandemic adjusted EBITDA margin at around 6%, although this is lower than the margin the group generated between 2011 and 2017, which averaged 7.5%. Management said it was able to pass raw materials prices through to customers and it tries to anticipate inflation before bidding. We forecast annual gross margin to remain at 19.4% and adjusted EBITDA margin at 6.4% in FY’22, resulting in €121.7 million adjusted EBITDA, slightly above the FY’19 pre-Covid level of €120 million, in line with management guidance.

Fives is particularly sensitive to changes in its customers’ willingness to invest in capex or infrastructure. The level of such spending is typically influenced by the general economic conditions, generally increasing during times of economic growth and decreasing during periods of economic contraction. However, we think the pent up demand in Fives end-markets, such as the automotive and aerospace sector, could support revenue and margins especially in the high precision machines division over the next two years. Global passenger car production (including China) is forecast to grow from 81 million units in 2022 to 91 million units in 2024 before the momentum softening with 92 million units in 2025 and 93 million units in 2026, according to IHS light vehicle production forecast. The other segments are less volatile during recessions. Some of the key materials used for the group’s sales are expected to continue growing and have worldwide demand. For example, according to Statista the global aluminum consumption is forecast to grow at a CAGR of 2.6% from 2021 to 64.2 million metric tons in 2029, while the global pipes market is forecast to grow at a CAGR of 3.7% from 2019 to 2025 according to grandviewresearch. The cement market is expected to continue growing at a CAGR of 4.8% from $609.3 million in 2020 to $680 million in 2026, according to Statista.

The next quarters will be critical for Fives to prove it can translate the backlog, not only into sales, but into EBITDA and passing input cost inflation to customers. Fives’ contracts are characterized by a fixed lump-sum price and the lifecycle of the group’s contracts tends to be long. For example, a contract for the provision of a system or an entire production line in a larger plant typically requires a lead-time of up to 18 to 24 months and contracts for the provision of a complete plant can take up to three years to fully complete. Any significant cost overruns have a direct impact on Fives margins.

Uncertainty remains on its ability to maintain free cash flow generation as working capital is difficult to predict. The group said that the shortage of components and basic manufactured subequipment continues to generate delays in reaching customers payments milestones, while accelerating cash out schedules to reserve supplier capacity and build security inventories. It added that the reversal of working capital occurred in the third quarter earlier than expected, hence it does not forecast a significant change in the fourth quarter. It said that the strong order intake in the third quarter should result in a working capital consumption in the first months of 2023 before reversing later in the year.

The group burnt €50 million in levered free cash flow (LFCF) in the first quarter and €8.8 million in the second, mainly due to working capital outflows. Cash balance was €238.6 million as of Dec. 31, 2021, decreased to €157.6 million as of June 30, 2022 and then increased to €187.2 million on Sept. 30.

The €115 million RCF should help the group to manage intra year fluctuations. As of Sept. 30, the revolver was €29 million drawn. 

Only the initial €50 million layer of the RCF, out of total €115 million, is available without any leverage condition. The excess (€65 million) is available subject to a leverage ratio test below 6x at the end of the previous quarter. The group states that the covenant leverage ratio came below 6x as of Sept. 30 making the additional €65 million layer fully available. The ratio is calculated by dividing the group’s reported LTM net debt of €787 million (which differs from Reorg calculated total net debt of €791 million because we do not exclude debt issuance costs of €3 million to €4 million) by reported pro forma LTM EBITDA of €135 million as defined in the table below. The latter includes add backs totalling €16.9 million mainly consisting of cost of bank guarantees and letters of credit, gains and losses realized on foreign exchanges, and gains and losses from asset disposals in the ordinary course of business.
 

Fives’ state-backed loan, or PGE loan, amortizes in 5 years so the company will have to make a €40 million amortization payment per year. The first installment of €40 million occurred in July 2022. Fives has around €6 million amortization payments yearly on its €30.6 million Italian government loans outstanding from the second quarter of 2022 onward and around €3 million yearly on its €16.3 million US government loans outstanding from 2024 onward.

We expect the French government to be supportive and potentially relax the PGE loan amortization schedule if liquidity came under pressure, for example if cash dropped closer to €50 million and €80 million, which is the minimum cash to run the business according to management.

We note that the French contract catering company Elior, which experienced some liquidity pressure over the last few years as reported in Reorg’s analysis HERE, managed to push back the first installment on its French government-backed loan by one year to October 2023 from October 2022.

Given the asset-lite nature of its business, Fives does not own material tangible assets that it could dispose of to reduce leverage in anticipation of launching a refinancing and in case it failed in reducing leverage organically. Fives could sell one of its business segments. Reorg calculates that the smart automation business could be worth around €485 million and the process technologies segment €355 million, using an average EV/EBITDA multiple of 9.8x of precent M&As transactions in the machinery industry, as presented below, and the EBITDA generated in FY’21 by the two segments. We think these are the most valuable businesses considering their EBITDA size and EBITDA margin as shown in the Business Overview section later.
 

Fives' capital structure is below:
   
The group’s €325 million 5% SSNs due June 2025 are trading at 72.8, yielding 18.9% as per Solve Advisors, while the €275 million floating rate SSNs due June 2025 are trading at 72.5, yielding 18.4%.

Other European credits whose notes are currently yielding in the range of 18% and 25% are Standard Profil, Upfield, Adler Pelzer and Consolis, as below:
 
Source: Source: Market data from Solve Advisors as of Nov. 22, 2022 and financial figures from Aggredium. To request an Aggredium trial please email sales@reorg.com

In our view, Fives has stronger fundamentals and somewhat better cash flow generation than Standard Profil, Ideal Standard, Adler Pelzer and Consolis, which we consider weaker issuers and would justify the lower spread per turn of leverage, or SPTL, of 391 bps on fixed rates notes. Fives is bigger in size, has diversified end markets and it provides mission-critical services to some of its clients. The relationships with its clients are long-lasting which creates barriers to entry to new competitors and it is uneconomical for Fives clients’ to break their contracts. Finally to some extent the fact that the group is involved in Green projects contributes to its ESG credentials. To note that Fives is an asset-light business, thus asset coverage may be weaker than other industrial issuers and any potential recovery from asset sales is limited.

Standard Profil, Ideal Standard, Adler Pelzer and Consolis have similar credit ratings to Fives (B-/ CCC+ from S&P and Caa1/Caa2 from Moodys) and their bonds mature slightly later in 2026. Fives fixed rate SSNs yield 18.9% whereas Consolis fixed rate SSNs yield 20%, Standard Profil notes 25.9%, and Ideal Standard notes 30.5%.

French precast concrete solutions company Consolis has been recently downgraded by Moody’s. The agency stated that the group’s profitability remained subdued and below their expectations in the first half of 2022. As shown in the table above, Consolis FCF generation is weaker than Fives, both on a levered and unlevered basis despite reporting similar EBITDA margin.

Moody’s recently downgraded German-headquartered autoparts supplier Standard Profil since according to the rating agency, the group has not generated positive free cash flow in the past four years, with the trend deteriorating each year. This was due to supply chain disruptions and rising raw material costs and high net working capital consumption because of revenue growth and increased inventory to be covered for supply chain pressures. In the last-12-month period to June 30, we calculate that the company burnt €211 million of LFCF (i.e. -62% LFCF margin compared to Fives’ 1.3% LFCF margin). Reorg’s analysis on Standard Profil is HERE.

Belgian sanitaryware and bathroom products manufacturer Ideal Standard features a weaker cash generation track record and there is lack of predictability over its performance given that it has been carrying out an operational turnaround for years and it continued to incur restructuring charges. This, in addition to the group’s history of debt and operational restructurings and the lack of guidance from management, continues to put downward pressure on its €325 million senior secured notes due 2026, currently quoted at 51.5. Reorg’s analysis on Ideal Standard is HERE.

Another similarly yielding credit is German-headquartered auto supplier Adler Pelzer, which has €350 million senior secured notes due in 2024 trading at about 80, yielding about 21.8%. Although net leverage is much lower than Fives, its notes mature earlier in 2024 and in the current challenging primary market we think Adler Pelzer may be unable to refinance the notes anytime soon without equity support. Reorg’s analysis on Adler Pelzer is HERE.

Fives’s fixed rates notes SPTL is instead higher than Upfield notes SPTL at 234 bps. Upfield features stronger profitability and cash flow generation. Plant-based spreads manufacturer Upfield, which is struggling with rising raw material prices, has its €685 million senior unsecured notes due 2026 trading 70.5 with a yield of 18.2%. Reorg estimated LTV through a waterfall analysis for Upfield is high at 103.7%. Though Upfield’s liquidity is not an issue, Reorg’s analysis highlighted that the former’s over-leveraged capital structure may require sponsor KKR’s support or a potential haircut on debt.
 
Backlog/Order Intake/Revenue

Fives backlog tends to translate into revenue in 18-24 months time, providing some revenue visibility over the medium term. The ending backlog is defined as opening backlog plus order intake minus sales over the period.

The backlog as of Sept. 30, was €2.5 billion, significantly above €1.582 billion as of Dec. 31 2021. This was mainly attributable to the signing of two jumbo contracts related to the process technologies operating segment, but also by a strong order intake in second and third as explained below. The two contracts were signed in the first quarter of 2022, totaling €400 million. The backlog in this segment rose by about two times to €1.142 billion as of June 2022 from €550 million in 2021. Management said they are confident that the current economic environment will not have major impacts on the two contracts, partly because the contracts relate to Green projects. One is a Greenfield project related to the steel segment in the U.S. and the other a Green Cement plant in Senegal.

The two charts below show the historical revenue and backlog evolution from 2017 until Sept. 30, 2022:
 
In the second quarter earnings call management said that even in 2020, during the heights of the pandemic, no contracts were canceled and there are penalties for customers canceling orders. Therefore we think the current backlog should translate into revenue in 18 to 24 months and not incur cancellations. Reorg thinks demand might remain elevated for the foreseeable future given that some of Fives’ clients in the auto sector for example, race to fulfill order backlogs after auto production was halted due to key components shortages. This is also supported by the order intake that is now above pre-covid levels.

The chart below highlights the historical order intake by division evolution:
  Excluding the two jumbo contracts in the process technologies division, the total LTM order intake was €1.014 billion which is materially above prior years. The total increase of small and medium size orders from the first nine months of 2021 to the first nine months of 2022 was €244 million. This compares to a pre-Covid order intake decrease of €2 million from the first nine months of 2018 to the first nine months of 2019. Small and medium size have short lead time which results in a quicker execution and less backlog accumulation. These projects make the pass through cost inflation to customers easier when compared to projects with bigger size that tend to have longer execution times.

Costs Breakdown/EBITDA

Reorg calculates that the group’s cost structure is predominantly variable, with costs of goods sold as a percentage of total costs ranging from 82% to 84%. 2/3s of the cost goods sold are made of subequipment Fives purchases from third party suppliers, which they subcontract; 20% is made of costs with personnel staff; 5%-10% energy costs, and the remaining with other costs. The remainder of the total operating costs relates to amortization, R&D and personnel expenses, as it can be seen in the below figure:
 
Given the asset light business, depreciation on property, plant and equipment and rights of use assets account for 2% of the group’s expenses.

EBITDA contractions are mainly caused by delays in revenue recognition due to projects being postponed or cost increases due to production inefficiencies generated by supply chain disruptions.

The group does not disclose quarterly EBITDA by division which makes Reorg unable to display LTM EBITDA figures by division. However the chart below gives an overview of how it developed in periods before and after the pandemic.
 
The high precision machines division tend to be accretive to the group’s EBITDA margins. However during and post recessions the segment struggled to pick up as a consequence of industries such as aerospace and automotive industries being negatively impacted during the crisis due to shortage of materials and lower demand for autos. All the other business divisions generated positive EBITDA in 2021, with the smart automation division benefiting from the growth in e-commerce during the pandemic as predicted in Reorg’s initial analysis HERE.

Reorg expects EBITDA in 2022 to exceed the pre-covid figure of €119.9 million, in line with management’s guidance. Moreover in 2023, despite an expected increase in inflation on costs (energy, wages, electronic components, freight) the topline should support EBITDA. Management predicts EBITDA in 2023 to reach an all time high of €140 million.

Working Capital

Working capital plays an important role in Fives’ free cash flow generation capacity. Working capital requirements are influenced by the invoicing time frames for contract assets from the assessment of work in progress and the collection of the related receivables. Consequently, delays in the progress of projects may have an impact on the timing of cash flow generation.

The group’s contracts have some key features that could impact working capital inflows. For example for process equipment supply contracts, for which the execution cycle is shorter, cash is typically received on signing the contract, as a down payment (generally between 5% and 15% of the total contract value); upon the delivery of the designs or other technical documentation at the end of the engineering phase (up to 20%); at completion of manufacturing (upon the issuance of a certificate for shipment) and/or upon delivery of goods (typically 60% together) and; at final acceptance by the customer (the remaining 10%, which is usually paid against Fives delivery of a guarantee to cover the requested warranty period).

In addition, for each contract recognized on a percentage-of-completion basis, the group determines the accumulated amount of costs incurred at the reporting date, plus profit recognized less progress billings and any losses at completion recognized. If the amount is positive, it is recorded as an asset under “Contract assets”. If it is negative, it is recorded as a liability under “Contract liabilities.” Advances and progress payments for ongoing contracts recognized on a completed-contract basis are recorded as liabilities under “Contract liabilities.” When estimated total contract costs exceed the expected sales price, a loss at completion is recognized, initially as a reduction in contract assets and subsequently as a provision. These line items have a significant impact on the group’s change in working capital.

The table below details the yearly changes in working capital evolution by item:
 
The same line items are not disclosed quarterly. Nonetheless based on the negative €43 million working capital consumption in the first quarter; close to neutral changes in the second quarter; the earlier than expected reversal of €36 million; and management predicted neutral working capital changes in the last quarter of the year, Fives should end the year with working capital outflows of around €8 million.

The chart below demonstrates the evolution of levered free cash flow before and after working capital changes. In 2019 for example, Fives generated cash before working capital movements but burnt cash after working capital movements.
 
Reorg forecasts Fives to generate levered free cash flow after leases of €7.7 million in 2022 based on the following assumptions:
 

• Revenue growth of 9.7% (somehow in line with the group’s guidance, that revenue will be above pre-pandemic);
• EBITDA margin of 6.4% (no guidance given);
• €22 million cash tax;
• Neutral working capital in the fourth quarter;
• €36.1 million of capex (2% of revenue in line with Q3’22);
• €40 million cash interest (in line with historical annual payments), though these would likely increase if the group were to refinance its debt).
   

 
Headquartered in France, Fives is an engineering group that designs and supplies plant equipment and provides services to companies in a wide variety of industrial sectors. It offers products and solutions ranging from standalone process equipment to integrated solutions and aftermarket services.

Fives’ management said it believes that the group is positioned as either the number one or one of the top three players in most of their addressed markets. In the past no single customer accounted for no more than 5% of the group’s total sales, and the top ten customers accounted for circa 27% of total sales. The 10 largest contracts tend to account for 20% of the group’s sales. Historically the company's largest long-term supplier, from which they typically purchase motion control and electrical/automation components, represented approximately only 1.2% of their total purchasing costs.

The company runs an asset-lite business, with an average capex as a percentage of sales in the past three years (2019, 2020, 2021) of around 1.5%. This is because a significant portion of the group sales is derived from projects which they execute on their customers’ sites or because some of their products are manufactured by third parties. Fives generally only insource manufacturing where fabrication is key to the value-added nature of its services or where proprietary know-how is required.

Sales Profile/Customers/Competitors

Fives offers products and solutions along a wide range from stand-alone equipment to complete systems. The company’s business segments include:
 

• Process technologies: design and supply of high performance and sustainable technologies for process industries, including process equipment and complete production lines for the aluminum, cement, steel, glass and energy sectors. Some of the customers and competitors include:
  • Energy customers: Air Liquide and Chevron; competitors: Honeywell and Chart.
  • Cement customers: LafargeHolcim and Qatar National Cement Company; competitors: FLSmidth and Polysius.
  • Metals customers: Alcoa and Vallourec; competitors: Outotec and GE.
• High precision machines: supply of high precision machine-tools for the automotive, aerospace and manufacturing markets. Some of customers and competitors include
  • Automotive customers: General Motors and Toyota; competitors: Junker and Dürr.
  • Aerospace and Industry customers: Airbus and John Deere; competitors: Electroimpact and Makino.
• Smart automation solutions: design, supply and installation of high added value sorting, handling and automation solutions for the e-commerce, retail and distribution markets. It also offers robotic solutions designed to automate manufacturing processes. Some of its customers and competitors include:
  • logistics customers: FedEx and Leclerc and competitors; competitors: Dematic and Vanderlande.
• Other: industrial maintenance and piping solutions for nuclear power plants, mainly in France, as well as holding activities. Some of its customers and competitors include:
  • Nuclear industry customers: EDF, Framatome, Alstom; competitors: Our piping solutions business unit mainly competes with Ponticelli, Boccard and Endel.
     

The below chart shows Fives sales breakdown by operating segment and geography for the last twelve months ended June 30:
   
Since May 29, 2018, the Caisse de Dépôt et Placement du Québec (CDPQ) and the Office d’investissement des Régimes de Pensions du Secteur Public (PSP), have been minority shareholders in the Group, alongside Ardian, which acquired a stake in Fives in 2012 and has retained a minority interest in the company. See 2021 financial report. At the time of the OM, CDPQ owned 30%, PSP owned 30%, Frédéric Sanchez, Fives CEO owned 29%, Ardian owned 8%, and other members of management owned 3%.

Fives CEO, Frédéric Sanchez, joined the group in 1990 and was appointed CEO and Chairman in 2002. He has remained in these executive positions since today. As per the last OM Sanchez controls 37.6% of the voting rights in Fives.

The chart below depicted the group corporate and financing structure as per the OM:
 

--Manuel Coelho, Giulia Rusconi