Alcoholic drinks distributor Conviviality (LSE: CVR) fell by 50% on Thursday after a issuing a profit warning late in the day. Shares in the firm, which operates Bargain Booze, Wine Rack and a wholesale supply business, fell by another 15% when markets opened on Friday.
The bad news is a little surprising, not least because the firm issued an in-line set of half-year results at the end of January. This was followed by directors buying £583,000 worth of shares in the market.
Perhaps we should have been suspicious about such buying, which looked co-ordinated to me. You’d certainly have to pay me to buy the shares after yesterday’s news.
What’s gone wrong?
The company said adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) is now expected to be 20% below forecasts for the year ending 30 April.
Two reasons are given: The first is an error in the financial forecasts for its Conviviality Direct wholesale business, which will reduce EBITDA by £5.2m; The second is that margins in the wholesale business have “softened across January and February”.
The company said sales and orders have been maintained, so this suggests to me that costs have risen for some reason.
Although it’s surprising that such big problems have surfaced with less than two months of the financial year remaining, that’s not my biggest concern.
Why I’d steer clear
Broker notes I’d seen prior to yesterday’s warning suggest that adjusted EBITDA for the current year was going to be around £70m for the current year. A 20% reduction takes this down to about £56m.
The company expects net debt of £150m at the end of the year, which implies a net debt-to-EBITDA ratio of about 2.7. That could be a problem because, according to January’s half-year results, the firm’s banking arrangements require this ratio to stay below 2.5x.
If the company breaches this limit when it’s next tested, its lenders could force it to raise fresh cash from shareholders in order to reduce debt.
Although the shares offer a forecast dividend yield of 12%, in my view this is almost certain to be cut. The shares look like a gamble to me at current levels. I plan to steer clear.
Another stock I’d sell today
My next stock is estate agency group Countrywide (LSE: CWD), which issued a grim set of results yesterday. These were ably covered by my Foolish colleague Ian Pierce, who spotted that the group’s net debt-to-EBITDA ratio has risen to a worrying 2.97 times.
Today, I’d like to explain a little more about why this is so risky for shareholders. As with Conviviality, Countrywide’s debt is subject to a net debt/EBITDA leverage covenant set by its banks. The company hasn’t disclosed its covenants, but we do know that its lenders “agreed an amendment to its leverage covenant” in February.
Despite this helping hand, the firm says it’s still at risk of breaching this covenant if it doesn’t achieve its forecasts for the current year. Worryingly, Countrywide says it would “be unable to meet its liabilities as they fall due” without the support of its banks.
This tells me that if market conditions don’t improve, there’s a good chance the group will have to tap shareholders for fresh cash this year. For this reason alone, I rate the shares as a sell.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.