(Debtwire) Matalan faces online and working capital headwinds but strong quarter provides optimism

23 October 2023 | 18:42 BST
Matalan has been a previous perennial guidance disappointer as online and supply-chain initiatives often encountered hiccups. But the UK retailer has emerged from its January restructuring with a noteholder group taking control and introducing some dynamic management changes. Its latest 2Q23/24 quarterly earnings were also encouraging and any sustained improvement could open a medium-term refinancing and eventual exit for the shareholders, according to three buysiders and an independent special situations desk.

The company reported 2Q23/24 results for quarter-end 26 August 2023 on Thursday (19 October) with IAS 17 (pre-IFRS 16) restated EBITDA jumping 92% year-on-year (YoY) to GBP 25.1m, as reported. The company had a strong store sales performance that boosted revenue growth, while quarterly gross profit margins climbed despite an erosion from FX swings. Gross profit margins were boosted by reduced freight costs and higher average selling prices offsetting cost price inflation.

Matalan quarterly operations benefitted from a strong June. Its June UK like-for-like sales grew by 14.8% YoY before slowing to 0.8% in July and 5.4% in August.

The company management on the 2Q23/24 earnings call reaffirmed their recent GBP 60m–GBP 65m FY23/24 IAS 17 EBITDA guidance, though this still remains below the GBP 75.7m FY23/24 earnings guidance given during its January recapitalization announcement. Matalan’s January projections on future earnings growth had also forecast GBP 97.4m IAS 17 EBITDA for FY24/25 and GBP 113.6m for FY25/26.

“The latest numbers were encouraging, and it was the first time I felt there was a plan not full of simple superlatives. They have a nice proposition, good products and are cutting overall lease expenses but need to improve online,” one buysider said. “They’ve reduced balance sheet inventory and have more desirable products, while they are making their stores more modern.”

The first buysider noted there had been a history of bad procurement, and the company often built-up inventory and then firesold it, but they are now shrinking the size of their stores, and their products command higher prices than the previous deep discounts. He argued that they are not fire-selling products even if EBITDA has been revised down to GBP 60m-GBP 65m from previous guidance given with the business plan.

“Matalan’s underlying quarter was strong. Sales and EBITDA were up, despite some complexities and significant FX headwinds, without which the quarter would have been up there with the best. The company confirmed that their current strategic review does not consider any material reduction in the estate,” independent special situations firm Sarria said. “Instead management sound a lot more front-footed about their plans and are considering expansion and have chosen to pay the coupons in cash.”

Matalan has had made some strong management hires in recent months with good track records in the sector. The company in March announced Jo Whitfield as new CEO and Karl-Heinz Holland as Chair, as reported. Jo Whitfield was the former CEO of UK food retailer and funeral care business Co-Op’s food division and was previously Head of Finance at Matalan from 2002 to 2008. Karl-Heinz Holland spent 23 years at discounter Lidl and was also CEO of Spanish discount food retailer DIA (Distribuidora Internacional de Alimentacion) and since May 2018 was Chairman of German discount retailer Takko. Matalan in April also hired Ali Jones as Chief Customer and Omni-Channel Officer who was most recently Customer and Community Director at Co-Op after previously holding roles at Woolworths Australia, UK department store Debenhams, UK supermarket M&S, UK retailer Next and Arcadia Group.

“The restructuring reduced a lot of debt and some of the management hires have been good, with the person from Takko for example,” the first buysider said. “The business is unique and offers low-end differentiated products to people. While it has never dominated the market previously, the new restructuring plan has given a runway on future liquidity, a credible strategic plan and a good capital structure.”

Challenges in store (and online)

The company still faces challenges regarding free cashflow, liquidity and its online offering which mean any possible refinancing or sponsor exit opportunity could still be several quarters away.

Current cashflows will also be thin if one takes a GBP 60m–GBP 65m FY23/24 EBITDA guidance and deducts GBP 40m guided capex, estimates of GBP 35m annual interest guided back in January and minimal cash taxes. This would mean GBP 10m–GBP 15m of negative free cashflow ahead of working capital swings.

Liquidity appears strong at GBP 136.6m net cash at 26 August 2023. This however follows the company’s decision to issue a second tranche of GBP 25m super senior notes in full on 22 June. Management on the earnings call warned that it made sense to draw the facility given potential working capital swings, though there is no punitive capital structure impact from this.

The company’s online offering is also a challenge with a 2Q23/24 online revenue decline of 35% due to product offer weakness from option and value reduction, website development after its launch, and tough market conditions with strong competition and a shift to physical store shopping. Online like-for-likes sales were consistently negative each month in the quarter (see chart below).

“Management did not convince on the online strategy. After several prompts from analysts, the origins of the poor performance seemed to be uncertain and possibly due to all three: traffic, basket size and conversion,” Sarria said. “We wouldn’t have minded some more focus.”

A second buysider noted the company had an online partnership with [UK e-commerce retailer] THG and was meant to grow online sales share, but the online sales this quarter were weak. He stated that the company previously disappointed on earnings guidance, and even if there is new management he takes the outlooks with a pinch of salt, while working capital can be volatile and Matalan will need to keep renegotiating leases every two to three years.

“For Matalan, the glass is half empty and the business has previously had higher EBITDA,” the second buysider said. “They drew down the GBP 25m that boosted cash, and they said margins were improving, but some of this was due to lower labour costs and margin improvement won’t be sticky as they’ll need more labour as sales grow.”

Matalan ahoy

Matalan in January finalised its recapitalization backed by a bondholder group representing over 70% of the outstanding First Lien Secured Notes – led by Invesco, Man GLG, Napier Park and Tresidor – who took control of the business. The agreement followed the conclusion of the strategic sales process launched on 22 September 2022.

The recapitalization involved a reduction in gross debt to GBP 336m from GBP 593m and up to GBP 100m of new capital to provide funding for operations and executing on its growth strategy. The earliest debt maturities would be January 2027, and the debt package allowed additional committed, undrawn funding, additional baskets and downside protection options.

Matalan issued three new classes of debt as part of the recapitalization (see January recapitalization pro forma reported capital structure below). Super Senior Notes of GBP 61.2m with a maturity date of January 2027 were issued in order to fully repay Matalan Finance plc’s GBP 60m asset backed term loan. Some senior secured notes of GBP 200m were issued with a maturity date of January 2028 to acquire the entirety of Matalan Finance plc’s GBP 350m 6.75% first lien secured notes, and new priority notes of GBP 75m with a maturity date of July 2027 were issued injecting extra liquidity into the group, according to the company 2Q23/24 financial report. The group then in June exercised its option to issue a second tranche of the GBP 25m super senior notes in full.

The recapitalization involved GBP 100m of new capital to support the business including the GBP 75m new priority notes and GBP 25m committed tranche of super senior notes. There was also a flexible debt structure with two GBP 20m debt incurrence baskets at the super senior and priority levels that provided room to raise further funds. There was also the ability to PIK the first four coupons on the GBP 200m new senior secured notes that can provide up to GBP 40m of liquidity support if required.

A potential exit for the high yield fund shareholders could be considered down the line if operational momentum builds. The Matalan restated senior secured notes were callable at 105 for the first six months before stepping down to 102.5 for the next six months and then to par thereafter.

Matalan’s GBP 200m 10% senior secured 2028s are indicated at 85.75-mid with a 14.6% yield to worst on Markit.

“We think the company could soon refinance, and it makes sense for them to look at the high yield bond market,” a third buysider said. “But one has to hope there is still not a ton of excess inventory they will have to sell.”

The second buysider noted that this is an equity story and in two years there could be a nice exit for equity holders. He argued that this business can generate a GBP 100m EBITDA, and the company can be sold and the existing debt refinanced. [Peers] New Look, Next, M&S are competitors, but Matalan has a better value proposition and can delever through cash generation and earnings growth.

Though the Matalan bonds are relatively illiquid there remains decent relative-value versus some other consumer names. UK-headquartered pizza chain PizzaExpress’ B3/B-/B rated GBP 335m 6.75% senior secured 2026s are indicated at 83.375-mid with a 14.4% yield to worst on Markit.

izzaExpress operations are in a difficult spot. Net leverage metrics have crept higher while cashflows off current modest LTM earnings look thin. But the UK-headquartered pizza chain has robust liquidity and time to grow earnings ahead of medium-term maturities. This leaves time to execute on a possible refinancing down the line, though a substantial OID may be required to get any new bond over the line and quarterly trading faces risks, as reported.

“The Matalan performance is in striking contrast to Pizza Express, who don’t suffer from the same FX headwind, but are more discretionary than Matalan,” Sarria noted. “We expected Pizza Express to perform more like Matalan – and they may yet. Matalan should probably first show a year’s worth of post-restructuring trading before it refinances the bond. Shareholders would of course benefit, but that will still be too expensive for a while. Ultimately, this could be an exit to a private equity firm in a few years, probably at multiple times the value the market currently implies through the bond prices.” 

Matalan’s net debt based on its 2Q23/24 financial report fair value minus attributable issuance cost reporting in accordance with IFRS 3 is broken down by Debtwire analyst calculations (see chart below).

Matalan declined to comment.

by Adam Samoon with capital structure by Priyanka Kotadia