Hedge Funds Get Burned in the Paris Suburbs
(Bloomberg Opinion) -- When a company’s stock is heavily shorted and the bonds yield nearly 20 percent, even a modest amount of good news can set off a giant relief rally. Vallourec SA, a supplier of steel tubes to the oil and gas industry, is a case in point.
On Wednesday evening the French group reported its first quarter of positive free cash flow in three years, thanks in part to stronger demand from customers in Europe and the Middle East.
Any cash that shows up is a welcome development for a company whose net debt is a whopping 13 times annual Ebitda.
The shares rocketed as much as 37 percent, while Vallourec’s 550 million euros ($567 million) of 6.6 percent coupon bonds maturing in 2022 gained 11 cents on the euro, and now yield a less eye-watering 14 per cent.
“We are really definitely advancing rapidly on the path to recovery,” CEO Philippe Crouzet told analysts. Hedge funds who’ve shorted at least 11 percent of available shares won’t be feeling quite so chipper (even if their financial exposure may not be all that big: Vallourec’s market capitalization is less than 1 billion euros these days.)
A bit of context shows that while Vallourec – based in the Paris suburb of Boulogne-Billancourt – is in remission for now, the patient isn’t yet cured.
Firstly, it helps to know that the fourth quarter is typically a much better one for cash flow and Vallourec benefited from a massive swing in working capital (probably by reducing a large build-up of inventory). The company still made a 100 million-euro quarterly loss, which is hardly reassuring.
While Vallourec is targeting a “strong increase” in Ebitda in 2019, this doesn’t mean indebtedness will start to decline. As I’ve noted before, the company won’t generate an annual positive free cash flow until Ebitda exceeds 500 million euros, something analysts don’t expect to happen for at last another couple of years. For context, Ebitda in 2018 was just 150 million euros.
Bondholders will be reassured by the Vallourec’s continuing efforts to cut costs and its promise to consider further asset sales. The company expects to comply with its banking covenants and it has ample financial firepower to deal with impending maturities – it has 740 million euros in cash and can still draw on a further 2.2 billion euros of loan facilities.
But until Vallourec can reliably generate more cash than it spends, the hedge funds will continue to hover.
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Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.
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