Performance Assessment
In my last coverage of B. Riley (NASDAQ:RILY) on Feb 18, 2024, I had issued a ‘Strong Sell’ rating. But shortly after, as I noticed a short squeeze was beginning, I updated my stance on Feb 27, 2024 to a ‘Neutral/Hold’, communicating this in a pinned comment:
From Feb 18 2024 to Feb 27 2024, RILY delivered a total shareholder return of -4.52%. During the same period, the S&P 500 (SPY) (SPX) returned +1.90%. This led to a RILY lagging the market by 6.42%. Hence, I consider this a successful outcome.
Thesis
Now, a couple of quarters of results have been published. And I believe the company’s operational health and cash bleed have gotten worse than before. Furthermore, I believe there has been a recent short squeeze already. Hence, I am reinstating my rating of ‘Strong Sell’ due to the following:
- On a core operations level, RILY is unprofitable and eroding value
- RILY is unable to meet interest coverage and is highly levered
- Its already negative tangible book value position has worsened, but the stock is bizarrely priced higher
- A recent short squeeze increases my confidence of further downside ahead
- RILY is a crowded short, so I am hesitant to actively bet against it
Like last time, my thesis is focused on B. Riley’s balance sheet and operating performance at the EBIT level, which occurs before the claims of equity investors, preferred equity investors and debt security investors. Hence, my view is applicable to all the different listed instruments under the RILY umbrella (RILY) (NASDAQ:RILYP), (NASDAQ:RILYL), (NASDAQ:RILYM), (NASDAQ:RILYG), (NASDAQ:RILYK), (NASDAQ:RILYN), (NASDAQ:RILYZ) and (NASDAQ:RILYT).
My pecking order is to prefer the securities maturing sooner with a lower yield. Therefore, RILYM, which matures in 2025, is my most preferred pick if I was forced to choose; I believe this has the lowest chances of capital erosion. The common equity shareholder class is my least preferred; I expect the worst returns here.
On a core operations level, RILY is unprofitable and eroding value
I believe RILY’s P&L has some highly volatile and unsustainable trading P&L elements which are best excluded when assessing its more stable and sustainable nature of operations. Please read the first section of my last article for more background on what these elements are. I refer to operating metrics excluding these volatile and unsustainable elements as ‘core’.
RILY’s core EBIT has worsened from my last coverage 2 quarters ago to a record low of $19.06 million in quarterly loss for the March 2024 quarter. I believe EBIT is a better measure of operating health here, since excluding D&A in EBITDA underestimates the company’s need to replace its asset base eventually. Nevertheless, even on a core EBITDA basis, RILY’s core profitability is in the doldrums:
Due to this negative core EBIT, the company is eroding value when we look at a steady business ROIC figure (excluding the volatile trading P&L):
Ultimately, this tells me that RILY does not have healthy core profitability.
RILY is unable to meet interest coverage and is highly levered
In the last 2 quarters, RILY has had to draw upon excess liquidity in its balance sheet ($3.19 billion as of Q1 FY24) to pay down interest costs because of a negative interest coverage ratio on both a core EBIT and normal EBIT basis:
Furthermore, due to weak operating earnings, the debt burden seems much larger as its net debt to annualized core EBITDA has spiked:
Overall, this means RILY is forced to have rapid erosion of its cash balances to service its liabilities. Its overall liquidity as defined by cash and short-term investment balance has fallen 24.6% since Q3 FY23; from $4.2 billion to $3.2 billion. At this rate of excess liquidity balances dwindling, there is a material balance sheet threat approaching the company.
Its already negative tangible book value position has worsened, but the stock is bizarrely priced higher
RILY’s net asset values continue to erode gradually.
In a forced sale of asset situation, I believe goodwill is not a reliable source of value, particularly since the company has started to have impairments of its goodwill in recent quarters. Excluding goodwill, net asset values are deep in negative territory; -$172 million as of the last quarter.
Yet, RILY today is priced at a 2.7x P/B multiple – higher than what it was in my last coverage of the stock (1.3x):
In other words, the market seems to not only be including goodwill in its valuation, but assuming there is value in excess of that within RILY’s business. I find this hard to believe. I think this is a mispricing of the stock. I believe the valuation is due to reduce down to at least 1.0x on a conservative basis, and likely much lower.
A recent short squeeze increases my confidence of further downside ahead
From a technical perspective, I notice that there has been a recent short squeeze in RILY. Hence, I think the path is clear now for a continued fall to new lows in the share price.
It is a crowded short, so I’m hesitant to actively bet against it
I rarely short stocks, but when I do, I like non-crowded shorts such as Cronos Group (CRON) (CRON:CA). I would have loved to short B. Riley’s common stock, however what holds me back are the high short interest levels at 26.25%:
And the high borrow fees for short positions on the stock (19.37% annualized). Due to the crowded nature of this trade, I believe the biggest risk to my bearish thesis is another short squeeze. I was able to identify a germinating short squeeze from a close reading of the technicals last time. If I am able to do so again, expect communication of a change in my stance via a pinned comment to this article.
Takeaway & Positioning
Over the past couple of quarters, B. Riley’s core profitability has worsened as it is making larger EBIT losses on its core business. This has eroded the return profile of the business. Furthermore, interest is not covered by a stable stream of operating earnings anymore, and the debt ratios have spiked. Altogether, this is leading to a bleed in the business’ excess liquidity, which has fallen 25% over the last 2 quarters.
B. Riley’s net asset value has also been eroding for multiple quarters now. Given recent impairment trends in goodwill and the unreliability of goodwill as a source of value in forced asset sales, I believe it is prudent to exclude this figure when assessing net asset value. When this is done, the company is exposed with a negative net asset value. Yet, the stock is bizarrely trading at 2.7x P/B. I posit that this is a mispricing.
RILY is a stock I would love to short if only it were not a crowded trade as evidenced by a 26.25% short interest and 19.37% short borrow fees. Hence, I will simply state my confident view of a ‘Strong Sell’ without actively betting against the stock.
Regarding the preferred and debt security classes, I prefer the securities maturing sooner with a lower yield. Therefore, I believe the 2025-maturing RILYM will perform the best among the various RILY securities, with the lowest chances of capital erosion.
How to interpret Hunting Alpha’s ratings:
Strong Buy: Expect the company to outperform the S&P500 on a total shareholder return basis, with higher than usual confidence
Buy: Expect the company to outperform the S&P 500 on a total shareholder return basis
Neutral/hold: Expect the company to perform in-line with the S&P 500 on a total shareholder return basis
Sell: Expect the company to underperform the S&P 500 on a total shareholder return basis
Strong Sell: Expect the company to underperform the S&P 500 on a total shareholder return basis, with higher than usual confidence
The typical time-horizon for my views is multiple quarters to around a year. It is not set in stone. However, I will share updates on my changes in stance in a pinned comment to this article and may also publish a new article discussing the reasons for the change in view.
Read the full article here