Close the Loop (ASX:CLG)

Where’s the cash?

The reality in investing is that you never get 100% of your calls right. Almost every fund manager recently stole the Roger Federer statistic of only winning 54% of his points whilst winning 80% of his matches to illustrate this concept. Personally, I prefer a Simpson’s quote:

Thankfully, since starting this Substack, we haven’t hadn’t many meaningful mistakes to report on. Unfortunately, this changed with the FY24 result for Close the Loop (ASX:CLG), and our biggest mistake was making it our largest position.

We previously wrote about Close the Loop here:

Close the Loop

In that post we wrote “The main negatives we have noted above are the lack of track record, the decline from the plastics division and the proof of cash conversion.” It is that proof of cash conversion that we need to come back here when reviewing the FY24 result.

The headline numbers of the result all looked positive. Revenue was up 59%, EBITDA up 85% and NPATA up 71%. These increases were all driven by the ISP Tek Services acquisition the previous year. The company did grow organically in the 2^nd half, with revenues up 6.5% from the 1^st half.

Source: Company filings

Despite these positive numbers, the 2^nd half of the year saw a significant rise in Net Debt as Free Cash Flow (FCF) came in significantly below expectations and a US$5m acquisition earnout was triggered.

Source: Company filings, author’s calculations

There is a seasonality in the cashflow, shown by the chart below comparing NPAT to FCF.

Source: Company filings, author’s calculations

The June half has always lagged the December half, so we can expect a decent cashflow result in the next result. However, the chart above compares the NPAT of $11.1m to FCF and not NPATA. NPATA came in at $26m, significantly higher than FCF and the reaction of the market suggests that most people believe that number is not meaningful. The FCF of $11.5m is more closely aligned with the NPAT of the last year.

I have included finance costs in the FCF above (I know technically I shouldn’t but it was easier), so if we assume a 30% tax shield and strip those out, we get FCF of $17.2m ($8.2m interest payments so $5.7m after the tax shield). The current market cap is $121m at 23.5 cents, placing it on7x FCF which is cheap, however the EV/FCF ratio is 9.5x. That difference is due to the debt and that is the key issue right now, if we had seen the continued decline in the net debt, we could have confidence in the outlook. At the moment, $42.6 of net debt against the $17.2m of FCF is not ideal. It is not disastrous, but when nearly half of your free cash flow is going to your debt holders, there isn’t much left for the shareholders.

The good news is that the interest costs will potentially decrease as the company is in discussions to restructure its debt post these results (the current interest rate appears astronomically high). The savings will hopefully enable them to reduce debt from the current position.

The other issue with the result, is despite the generic outlook statements, there is no specific guidance for FY25. The company states that “the outlook for FY25 is encouraging” and they are “positioned to grow revenue and earnings by several times in the next 3 to 5 years.” Despite these positive statements, the proof to date has been lacking.

Overall, we were disappointed by this result despite the positive headline numbers. We expected better cashflow and lower debt levels. We haven’t bought or sold anything at this point, we still believe in the long-term prospects of the company but it still has a lot to prove. We thought this result would help prove some of those points but unfortunately it didn’t.

Just a friendly reminder that none of the above is investment advice, it is factual commentary on a portfolio run by the author.