Connect Group – a dangerous-looking balance sheet, but good cash flow

Connect Group (LSE:CNCT) has not had an attractive-looking balance sheet for many years. It had/has very high levels of intangible assets, especially goodwill, due to paying excessive prices for acquisitions. Even after including those doubtful “assets” in its balance sheet it could barely report a positive net current asset value.  On top of that, it used to carry over £100m of bank debt – now down to between £50m and £90m depending on which day in the month you look at it.
Now that it has written-off large chunks of goodwill and other intangibles it shows a negative net asset value, NAV, of £74m.  Excluding intangibles the net liability is £84m.
Balance sheet data.
£m August 2019 August 2018 August 2017 August 2016
Non-current intangible assets 10 51 107 165
Other non-current assets 22 44 51 62
Trade and other receivables 124 130 98 139
Other current assets 57 32 84 52
TOTAL ASSETS 213 257 340 418
Trade and other payables -174 -176 -136 -199
Other current liabilities -56 -64 -91 -83
Non-current liabilities -57 -63 -88 -123
NET ASSETS -74 -46 25 13How it survives its poor balance sheet
The BS is heavily dependent on very large amounts of credit granted by its suppliers, mostly publishers - trade and other payables are £174m. Connect does not pay for newspapers and magazines until sometime after its customers have paid them.  Newsagents pay via weekly  direct debits but across the Group the average credit period taken by customers is 22 days but the average credit period taken by Connect from its suppliers is 31 days.
A concern would arise if this positive cash cycle is interrupted, meaning that Connect would need to borrow more from banks.
However, there is reassurance in the contract terms with publishers - they contain clauses granting long credit periods, and the contracts last for five years.
Net bank debt
While the company has brought down its debt levels by selling businesses and by applying some of its positive free cash flow to debt repayment, the indebtedness numbers are still very high.
£m August 2019 August 2018 August 2017
Opening net debt -83.4 -82.1 -141.7
Free cash flow to equity +8.3 +20.2 +28.7
Pension deficit recovery -1.6 -4.7 -4.8
Dividend paid 0 -24.1 -23.6
Disposal proceeds 0 +12.9 +58.2
Cash flow from discontinued business 0 -8.8 -1.1
Finance lease creditor and other +2.8 +3.2 +2.2
Closing net debt -73.9 -83.4 -82.1
Net debt/EBITDA 1.9x 1.8x 1.2xSince yearend £15m has been raised via sale and leasebacks. Also another six months of stable trading to the end of February has probably reduced debt levels by around £6m.
Covenants on bank loans:

• Net debt/adjusted EBITDA ratio must be below 2.75. In August 2019 it was 1.9.
• Interest cover: adjusted EBITDA/net interest amount ratio better than four times. In 2019 it was 7.2 times
• Adjusted EBITDA/Fixed charges greater than 1.75 to 1. In 2019 it was 2.1.

So, clearly, bankers are lending on the basis
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