Naked Wines (WINE.L, WINE LN)

Plonk in a Panic

*Please read the disclaimers at the base of this report.  The author has a short position in Naked Wines. Does not constitute a recommendation to buy or sell the securities mentioned herein. Do your own due diligence.

I don’t often write about wine, despite drinking far more than I should. That said, I’ve been short Naked Wines (WINE.L; WINE LN) for quite some time now after experimenting with being an Angel (a subscriber to their wine bank). I can’t say the wine on offer knocked me sideways, unless we are talking about the crashing hangovers I experienced the next morning. But each to their own. As for the stock, despite shorting it, I didn’t write about it before as I was having too much fun messing around with oil and gas value destruction, but after this latest press release, I can no longer resist the temptation.

As we have seen from the latest release, the publication of their annual results has been delayed pending auditor sign off. Red flags waving all over the place then, clearly. On top of this, sales for the 2024 year are tracking down, materially (on track for GBP 300m rather than 350m approx in 2023 (year end April).

But look a little closer and even the statement of 2023 results raises question marks:

Look at the third bullet. “Closing cash of GBP 10 million”. Seems pretty innocuous, right? Well yes, until you read through their previous statements, like the one in late April 2023 (Pre close trading statement) which talked about a “net cash balance of GBP 10 million”. According to that release their $60m credit facility was “fully operational”. Now as we all know, closing cash is not normally the same as net cash. Net cash is usually defined as cash balances net of overdrafts and debt, whereas “cash” or “closing cash” is just a gross figure. However, on March 10th, when the company put out its Silicon Valley Bank release, the company noted it held GBP 32m of gross cash on account. Being charitable then, I assume we should interpret this more recent statement as suggesting there are some financial liabilities or loans (ie some of the credit facility) that have been drawn as of year end, and that the 10 million figure is net of that drawn credit given the earlier 32m gross cash announcement. But it still represents a red flag, partly given the ambiguity of the language, but more given the noticeable lack of a cash buffer in a business with questionable profitability and no real fixed assets or annuity stream.

Silicon Valley Largesse

Then we come to the credit facility. This credit facility is effectively a working capital facility secured against their US inventory (in other words their unsold plonk). It was set up with those bastions of financial risk management, Silicon Valley Bank, and now sits with First Citizens Bank. It’s unclear how much money has been drawn from this facility. Certainly if we look at the release it suggests that 49m GBP total liquidity is outstanding, which presumably includes the net cash of 10m GBP and 39m GBP left of the facility (or around $50m.). Assuming the size of the facility is unchanged at $60m, that would imply gross cash of GBP 18m approx (10m pounds + $10m in sterling).

Those numbers are quite some way from Naked’s claimed gross cash of 32m GBP in early March and net cash of GBP 23m at the Half Year reporting date (September 2022). Obviously there may well be good explanations of this, and the inferred numbers may be wrong. However, the direction of travel is clear and it doesn’t look healthy.

Wine Lake

Add to this several other factors. One is the burgeoning wine inventory at Naked which was over GBP 200m at the half year results (see below). This and the declining cash balance is the main reason Naked’s current ratio (current assets/liabilities) hasn’t slipped into negative territory so far. While not published, its fair to have a reasonable suspicion that Naked’s current ratio covenant on its credit facility (inventory secured) is >1. If we simply look at receivables to payables, the payables number is 10x the receivables. Put simply, Naked is entirely dependent on its Inventory for its solvency, and the “liquidation value” of its inventory being approximate to the booked amount. Note also that Deferred Angel money, the money that wine club members pay in monthly, is effectively a claim on inventory, and in extremis can be returned to the member via their credit card. As such it represents a debt to the “angel” or retail subscriber which ultimately is returnable, either via wine or via cash return. In a growth environment, where the company is aggressively advertising and subsidising new subscribers and where the market appetite for the product is high, it is self-replenishing, and can even grow, however, in the environment we find ourselves in today, that is far from the case.

.There is a second point. While inventory has spiked up in the last year to 18 months, partly due to over-aggressive assumptions during the lockdown period, there haven’t been material write off’s of late. The only material provision was for approx GBP 7.5m at the half year stage, relating to the company’s US wine inventories. If we look at Naked’s main competitor, Laithwaites (or Direct Wine Holdings ltd), we find its inventory to sales ratio is about 16% (65/395). Meanwhile, at Naked that ratio is a staggering 60+% at the half year mark. If we normalised to say just a 30% ratio, (almost double Laithwaites, and in-line with Naked’s own pre lockdown figures) we would have to write over GBP 100m of inventory off, and as a result the current ratio would be <1x, especially if cash balances have declined as implied by recent reg news releases. That would potentially put Naked in covenant breach and at the mercy of its creditors.

And this is where the circularity of Naked’s inventory credit facility hits home. The wine itself, is broadly speaking, everyday drinking plonk. It’s not vintage Margaux. Instead of appreciating in value, it depreciates, rapidly, if not drunk. Today’s drinking plonk is tomorrow’s salad dressing. Meanwhile, the debt, and the obligations of the facility remain, and do not depreciate.

If, as we strongly suspect, the liabilities implied by the 80m plus payables figure (at Sept 22), the drawn credit facility (at least $10m, possibly more), the Angel liabilities (87m+), collectively outweigh the adjusted current assets (ie a much lower “real” inventory number of say GBP100m, modest receivables and cash), then there is a major going concern question hanging over the business, with near term liabilities outweighing near term assets: a working capital deficit. The lack of money remaining to invest in the business and in marketing (essential loss leading subscriber acquisition costs on a half case of wine) would effectively signal a “death spiral” situation, with the company at the mercy of its creditors.

Going Concerns

The coup de grace for a business like this, given the apparent unavailability of equity markets given current valuations (approx GBP 70m market cap), would then be a senior secured working capital facility of whatever the shortfall in working capital would be, covenanted effectively to “take-under” the business as soon as the covenants were broken. This would presumably be much more appealing for other better capitalised hard nosed purveyors of plonk like Laithwaites (ie Direct Wines) than buying the equity outright.

All this then, might potentially explain the tardiness of auditors signing off the accounts. A return to sustainable growth, at any rate, only seems achievable with the injection of material new capital, meaning either equity or credit that eventually becomes swapped for equity. Neither should be an appealing prospect for existing shareholders. But then again, nor is receivership. Certainly, with a working capital situation like this, if you are not growing, and don’t have a path to growth, then you are probably that humble snack that follows a night of overindulgence - toast.

DISCLAIMERS

The information contained above is not intended to constitute and should not be construed as investment advice and should not be construed as an offering or a solicitation of an offer to invest in any product or share.  It is for personal use and information use only.  It should not be relied on in the context of the investment objectives and financial situation of particular needs of any particular person or class of persons, and relevant advice should be obtained before taking any investment decision.  The information above has been obtained from sources that we believe to be reliable and accurate at the time of publication, however, we give no warranty of accuracy as to the information or opinions offered above.  Opinions given above are given at the time of posting and are subject to change without notice.  The value of investments may fluctuate and you may not receive back the amount originally invested. Past performance is not  a guarantee of future performance.   At any time we may have a position long or short in a given company under discussion.