XPF & CRPR - Two exciting prospects continue to be uninvestable for now
XP Factory and James Cropper remain on the watchlist, for a while longer
Having gone through both their most recent trading updates, I was hoping they would be showing signs of sustainable momentum in profitability that would give me confidence to invest. While XP Factory did show strong revenue growth, profitability still looks as elusive as ever. On the other hand, the case for James Cropper has gone from early signs of profit momentum, to now being in the covenant-risk bucket for me. I expand my thoughts on these two below.
XP Factory (XPF)
Their latest trading update (18th Jan) failed to address what I really care about - are they on the path to break-even profitability, and proving that they have a business model that can scale profitably?
Lots of information on revenues, Like-for-like revenues, growth rates. Some details on site-level EBITDA, and then really nothing at all below this line in the P&L. Why? I suspect it is a conscious choice of omission because they are horribly in the red, once you go below the site-level EBITDA line.
This is not a surprise. Their Half Year results, where they have to state the entire P&L, showed an operating loss of -£1.6m. I was hoping that, in the seasonally stronger H2, that this would swing wildly into the black and therefore on a FY basis they finally prove they can operate profitably (even on an adjusted level). Unfortunately, they confirmed they are "trading to market expectations”, which if taking the broker forecasts, is still a loss for the FY Mar24.
Quite why they are unable to make a profit, with a chain of 24 Escape Hunt sites and 19 Boom Battle Bar sites, is a mystery. I can forgive them if they had a small chain of less than 10 sites, but there are enough sites now to spread out any central costs, D&A, and interest costs.
The key killer for me, when looking at the P&L, is the huge D&A costs. £3.4m in H1 alone. I’d say the run-rate is probably closer to £7-7.5m/year now, given additional openings and capex investments. That is quite a lot, on a turnover of £44.5m a year. Given this is never going to be a high margin business; they are aiming for only 20-25% site-level EBITDA margins on the Boom Battle bar business, which definitely does not support the level of D&A that is being charged.
So where does this leave me? Still very sceptical if their current business model works. Fundamentally, Boom Battle Bar does not seem a sustainable business model to me yet. For the next 1-2 years, they should be OK in terms of positive cashflow, which will mirror the EBITDA, as they won’t need to invest maintenance and refresh capex for their still-new estate. But I can foresee, from 2025-2026 onwards, that increasing capex needs to keep their estate looking good, would then pressure their cashflows. If they are unable to get their site-level EBITDA margin up to a much higher level.
Lots of investors have gone into this, tempted by the siren song of high growth rates, and a sexy growth sector (experiences). While I think they have created an entertainment format that is a hit with consumers, it remains to be seen whether it can be profitable for investors.
I continue to wait and see on the sidelines.
James Cropper (CRPR)
They were showing some interesting shoots of momentum earlier this year. Their Advanced Materials business was growing strongly, and highly profitable. Their Paper business showed signs of stabilising, and returning back to profitability.
Alas, both these narratives have been derailed in the Oct-Dec period after their first half. Their trading update (17 Jan) was a massive profit warning. The scale is staggering! H2 is now expected to do £46.5m revenues, down -29% from broker forecasts of £65.5m. Last year they did £68.1m. Dire all around.
H2 will now be loss-making, approximately £2m adj LBT I am guessing.
In the recent past, the Paper division was already loss-making, and so the losses here have probably worsened slightly. This was bearable in the past, as the Advanced Materials division generated amazing profits (+£9m operating profit in FY Mar23). They haven’t guided whether they are still profitable in Advanced Materials. I would hope so, but the scale of the total revenue decline (not broken out by Paper and AM) makes me worried.
All this can still be fine for an investment case. I can put up with small losses, as long as there is a clear story and pathway to recovery. However, the debt is now an issue. Net debt as of HY Mar23 was £13.3m. They have assured that Net Debt by Mar24 will be “slightly better than expected” although not stating what expectations are/were! Presume they can’t have gotten much better than £13.3m, given that H2 is PBT loss-making.
There are two covenants for their banking facilities. Net Debt/EBITDA of less than 3.5x, and EBITDA/Net Interest of more than 4x. I won’t go through my estimates in detail, but for me I think they will pass the test as of Mar24, but the margin of safety is probably only in the 15-30% range. Given than H1-25 will be worse than H1-24, we can the expect towards quarter-end Dec24, Mar25 that there could be a chance of a covenant breach. The facilities also expire sometime Apr-Aug 2025. The company is already projecting that the AM market will not start growing until 2026-2028. And there is no guarantee that Paper will have enough momentum in FY25 to get back to strong profitability.
One should always pay attention to what is missing in an RNS update. In this case, no re-assurance on covenants in this TU means that it might be a grim story there. You can bet when they do disclose potential risk with the covenant, that the share price will take another big lurch down.
So I continue to have James Cropper on my watchlist.