The Thomas Cook (LSE: TCG) share price has been as erratic as a plane with a chimp at the controls. It pulled out of a dive to an intraday low of 8.33p early last week, and has since rapidly gained altitude, trading at 18p, as I’m writing.
However, I don’t think it’s clear skies ahead for investors. Indeed, if I owned the shares, I’d be taking the opportunity to sell on this bounce. Let me explain why.
Something has to change
Debt has become a big, big problem for Cook. The table below shows the trend in net debt at the half-year ends (31 March) and full-year ends (30 September) for recent years.
(£m) | 2014/15 | 2015/16 | 2016/17 | 2017/18 | 2018/19 |
Half-year end | 700 | 825 | 794 | 886 | 1,247 |
Year-end | 139 | 129 | 40 | 389 | 750* |
* Based on company guidance that year-on-year net debt will increase by a similar amount to the half-year-on-half-year (£361m).
The seasonality of the business means net debt is higher at the half-year ends (end of winter) than at the full-year ends (end of summer). But it’s the rapidly rising trend in net debt at both period ends since 2016/17 that is the clue to the problem.
The table below shows key numbers from the cash flow statements of 2016/17 and 2017/18.
(£m) | 2016/17 | 2017/18 |
Net cash from operating activities | 496 | 139 |
Capital expenditure | (206) | (210) |
Acquisitions/disposals | 7 | 7 |
Interest on debt | (144) | (135) |
Other financing activities | (31) | (146) |
Increase/decrease in cash | 122 | (345) |
The company generated net cash from operating activities of £496m in 2016/17. This was enough to cover all its capital expenditure and financing activities (including £144m interest on its debt), and there was £122m left over to add to the coffers.
However, in 2017/18, net cash from operating activities was just £139m — barely enough to cover the £135m interest on the debt, let alone other financing activities and capital expenditure. It had to take £345m from its coffers to pay for these, so net debt leapt.
This was a result of a more competitive market in 2017/18, and it’s continued this year. Clearly, if a company’s only generating enough cash from operating activities to cover interest payments on its debt, the situation is unsustainable, and something has to change. This is the situation Cook is in.
Time to cash out?
Cash generation isn’t going to improve for the foreseeable future. Indeed, it could get worse, particularly if holidaymakers grow nervous about booking with the company.
Asset sales to reduce debt? In view of the fact Cook is a distressed seller, I can’t see bidders offering top dollar for any of the company’s assets, which is what I think would be required to make a significant difference.
A ‘white knight’ coming in with an offer for the whole company? I don’t think this idea has legs either, as my colleague Roland Head has explained.
No, Cook looks to me to be very much on the flightpath to a debt-for-equity swap. Typically, this would leave current shareholders owning a small fraction of the refinanced business, with today’s 18p shares being worth a few pence at most.
Finally, the company’s bonds are trading at around 35 cents in the euro. The debt market tends to be a far better barometer of outcomes than the equity market in these situations.
The level of discount on the bonds further convinces me that Cook’s firmly enough on that flightpath to a debt-for-equity swap to make it worth cashing out of the shares and parachuting safely from the plane.