(Debtwire) Matalan hopes self-work will deliver results in crucial third quarter
29 Oct 2024 10:55 GMT
Summary
Company focuses on controllable factors to improve operations and meet revised guidance
Matalan makes progress on gross margin rate increase and positive Q3 sales trend
GBP 100m cash, long maturities and debt basket capacity support turnaround efforts
Matalan’s recent performance has disappointed investors with the yield on its 2028 bonds rising to 20%. Heading into the lucrative third quarter, the UK clothes retailer has to ride a challenging market environment and hope that its focus on the factors under its control achieves results, as it has a long way to go to meet its FY24/25 guidance, according to buysiders and a deepdive analyst.
Earlier this month, Matalan reported a 32% drop in second-quarter EBITDA year-on-year (YoY) as the topline fell by almost 15%. It revised down its full-year guidance to GBP 57m-GBP 62m in FY24/25 IAS 17 EBITDA. That is down from the previously guided GBP 80m-GBP 85m range and well below the GBP 97.4m initially targeted in its January 2023 business plan.
The market has reacted to the results. Its GBP 200m 10% senior unsecured 2028 notes are down around four points in the secondary market, with IHS Markit indicating them at 76.42-mid yesterday (28 October) yielding 20.29% to worst.
Some investors are sceptical that it will be able to make even its updated guidance. With half the financial year already gone, the company has only generated GBP 20m EBITDA, though the third quarter is the biggest profit generator thanks to Halloween, Black Friday and the run up to Christmas.
“We are astonished by the strong guidance for Q3,” independent special situations desk Sarria said. “The weather has been good to them and back-to-school is a big theme, but Matalan still have freight costs and supply impasses to overcome, and even though we’ve all been reading about an improvement in UK consumption, we wouldn’t have guessed that apparel retail is at the forefront of it.”
There are many factors affecting recent performance that are out of Matalan’s control, according to a spokesperson. It continues to operate in a challenging trading environment thanks to increased freight costs impacting performance. The spokesperson also said there was an unusually wet summer and muted consumer spending. Met Office datasuggests rainfall was average in summer 2024. UK consumer confidence has been falling heading into the budget, according to the GfK Index.
Some investors also felt that some of the damage was self-inflicted. As previously reported, management said on its 17 October earnings call, that the decision to cut prices by 8% earlier in the year was correct in theory, despite the uninspiring sales figures. The price cut was heavily promoted in the British press. But Matalan’s market share actually shrunk from 2.6% to 2.2% year-on-year in the second quarter.
Chairman Karl-Heinz Holland said the decision was theoretically a good one but did not work in practice as the necessary stock was not in place. “We had availability issues, size availability issues, micro-location availability issues...,” he said. Click HERE for the full transcript.
The former CEO Jo Whitfield argued on the June investor call that historically the business has been overstocked. She and her team therefore took the decision to reduce inventory levels during the second and third quarters, only to come up against two to three weeks of interruption to supply due to the Suez disruption.
A Matalan spokesperson told Debtwire: “The decision to reduce prices was to correct previous price increases and remain competitive in the market, and the fact we didn’t see a volume uplift was largely owing to availability issues arising from the Suez crisis.”
Whitfield has now left without warning and after just 18 months of service to pursue a “portfolio career”, according to Holland. Her appointment and that of Holland in March was presented as a bright new era for Matalan given their experience at larger retailers Takko, Lidl Group and Co-Op. Holland had been at Lidl for 23 years before leaving over a strategy split in 2014. He was also Chairman of the Advisory Board at Takko, the German discount fashion retailer, before resigning in July 2023, shortly before it completed a restructuring.
A buysider said they found the departure odd, though Whitfield’s decision to hire new people early on had likely been a drag on fixed costs exacerbated by the weaker than forecast sales. “The loss of the previous CFO, Stephen Hill, was a negative for me as he was well-regarded,” the buysider added. Hill had worked at Matalan for almost 23 years, having started as a commercial analyst in his first non-graduate role, according to hisLinkedIn.
“We started the year bullish on Matalan, but UK retail turned out to be even worse than we thought, and we’ve now been cautious on the name for some time,” Sarria said last week. “It’s been death by a lot of cuts for Matalan, and Jo Whitfield’s departure somewhat documents that, although we think the company could have performed even worse. The 18% yield suggests the bonds are trading where they should, and Matalan have time to improve operations before people sit down to refi the bonds.”
Do it yourself or not at all
While there is little Matalan can do to resolve some of its supply chain issues, there are many other areas of the business it can optimise. A company spokesperson pointed to improvements in the gross margin rate delivered in 1H24-25, and a positive early trend in like-for-like sales and margin growth in 3Q24-25.
Matalan has worked on its purchasing and reduced markdowns, boosting the gross margin in the second quarter by 5bps from 46.2% to 51.2%. Like-for-like sales in the third quarter were up 3.8% with a much improved (+19.3%) margin at the time of the results. It’s also investing in its stores and will open a new shop in Hereford next month.
Matalan also has GBP 100m in cash, which gave it confidence to pay the October coupon payment in cash, not PIK, the last time it would have been able to do so, according to aDebtwire credit report. Per the report, Matalan has a further option to raise around GBP 40m through debt basket capacity at the super senior and priority levels, with lender approval.
“We remain focused on those things that we can control and have made improvements to address those issues, including to our ranging and availability alongside maintaining tight control of costs,” the spokesperson said. ”Matalan is on a firmer operational and financial footing than it was 18 months ago, and our liquidity remains strong. We are encouraged by the positive performance we are seeing in current trading and, with a laser focus on the areas we can control; we continue to make progress in our transformation journey.”
The earliest maturities Matalan faces are the January 2027 deadline on its super senior notes. That combined with its strong current liquidity means that it still has time to improve operations and get leverage down before it needs to launch a refinancing.
The company is potentially missing an attractive primary market window, however. German peer Takko, which also restructured in 2023, is currently in the market with a new high yield issuance, that is marketed off a low 1.7x net leverage figure. Even with those metrics, the B3 / B- / BB- rated company may have to pay more than a 10% coupon on its new notes, according to a Debtwire bond preview. Takko has worked hard on reducing markdowns, using a data-driven approach to understand when and where to reduce prices, leading to a record 65% gross margin in September, as reported.
A second buysider acknowledged that Matalan’s recent results have been disappointing, but there are also some encouraging signs. “They were much better this year at getting the right product mix,” he said. “That is the key to the success of any retail business. The slippage is in the topline, but I think they know what they need to do there. They have been unfortunate as their customers have been some of the worst affected by the cost-of-living crisis.”
Crucially, time is on the company’s side, the buysider added. “When the stars align, it doesn’t take long for cashflow to work,” he said. “They’ve clarified what they are using the Capex for, they are brushing up on the stores and they spoke about diversifying the supplier base as well. At the moment, they are 1-0 down, but I think they will get there without going into extra time. They will win 2-1.”
by Claude Risner and Adam Samoon with capital structure by Adeline Bockarie
Adam Samoon
Debtwire Europe
Head of High Yield