(Debtwire) Matalan operational recovery leaves refi opportunity open with potential second lien upside

Matalan has been dealing with a number of challenges in recent years including cotton price headwinds, difficulties at its Knowsley warehouse, FX volatility and – last but surely not least – the impact of the pandemic. But the UK retailer has an uncanny knack of weathering the storm and with guided GBP 98m-GBP 100m FY21/22 IAS 17 (pre-IFRS 16) EBITDA, earnings are nearing pre-Covid levels. This means a refi attempt could soon emerge, providing second lien bonds with large room for upside, according to four buysiders.

The company yesterday (17 January) reported 3Q21/22 results for quarter-end 27 November with management noting on the earnings call that the company continues to monitor market conditions and evaluate refinancing opportunities, as reported.

Matalan guided that FY21/22 IAS 17 adjusted EBITDA could be up at GBP 98m-GBP 100m, which would mean operations are back towards pre-Covid levels. Matalan delivered an IAS 17 adjusted EBITDA of GBP 80m at FY19/20 and GBP 102m at FY18/19.

Operational momentum should continue going forward. The company disclosed that EBITDA for the month of December had been in line with its prior year comparable period while in January and February it should beat Year-on-Year (YoY) comparable given it will unlikely face any of the lockdowns that hampered the prior year’s months.

“The presentation was more like a roadshow. Freight costs could be a risk but there is decent selling power,” one buysider said. “They are not a fast fashion retailer saying they have long shelf lives, and late products coming through does not impact Matalan as much even if there is seasonality.”

Peer Next reported its trading statement for the eight weeks to 25 December on 6 January, noting that stock levels were materially lower than planned in the run-up to Christmas but that sales remained robust, showing the strength of the underlying consumer demand.

Next were in good shape while Matalan talked about formalwear being good, the first buysider noted. “Full price sales continue to be strong and will offset cost pressures. They are operating well and have easy comparables in 4Q and 1Q. FY22/23 should be better.”

The company’s IAS 17 EBITDA upcoming YoY comparables were just a negative EUR 17.9m for 4Q20/21, positive GBP 15.9m for 1Q21/22 and positive GBP 38.9m for 2Q21/22. On an IFRS 16 basis, respective comparables were positive GBP 8.1m, GBP 41.8m and GBP 61.0m, as noted in Debtwire’s credit report.

“I’ve been a fan and these were great results. They have done an incredible job on cost headwinds and the cashflow position is good with nice earnings,” a second buysider commented. “I’m optimistic. Freight costs will be a headwind for everyone but they [Matalan] can maintain margins.”

Company EBITDA growth is great and the guidance is promising versus 2019, he continued, adding that GBP 100m IAS 17 EBITDA could be normal for this business.

Deleveraging on the cards

Matalan’s net leverage metrics are at manageable 5.3x level off IAS 17 adjusted EBITDA and 5.4x off post-IFRS 16 earnings, according to Debtwire’s analyst calculations. With earnings set to improve at FY21/22 given the guidance, metrics could reduce further.

There is no liquidity pressure in the meantime with management on the earnings call disclosing that the company had a GBP 163.3m cash balance post-quarter at end-December 2021 while payment arrears that had been deferred reduced to just GBP 14m at end-December.

The company has the potential to be free cashflow generative. With a 3Q21/22 LTM adjusted cashflow from operations of GBP 146m after deducting a GBP 17m working capital swing from adjusted funds from operations, it could face just GBP 20m capex (GBP 10m-GBP 12m maintenance capex was guided with a ceiling for total capex of GBP 40m), GBP 80m interest and minimal cash taxes, which would mean potential for around GBP 44m-GBP 46m free cashflow, the first buysider estimated.

Matalan is also taking steps to develop its online proposition by partnering with online retailer The Hut Group and also has its own e-commerce plan under which it hopes to involve its Knowsley warehouse distribution capabilities.

“I was pleasantly surprised with the results and they are back to pre-COVID levels,” a third buysider said. “Given where net leverage is now and it should reduce by FY21/22, it is not an unreasonable level to do a refinancing.”

They should be able to get the refinancing done, the second buysider concurred. “They won’t be far off the FY21/22 guidance and Knowsley [warehouse] capacity can be increased while the online partnership means extra functionalities.”

The next Douglas?

Matalan’s B3 rated GBP 348m 6.75% first lien secured 2023s are indicated a point higher following the results at 98-mid yielding 8.8% while the Caa3/CCC- rated illiquid GBP 79m 9.5% second lien secured 2024s are broadly flat around 78-mid yielding 23.6%, according to Markit.

The first liens are callable at 101.6875, stepping down to par from 31 January 2022, while the second liens are callable 104.75, stepping down to 102.375 from 31 January 2022.

Dealing with the second liens could be key to achieving any refinancing, and second lien bond prices could rise further, three of the buysiders noted. The second lien notes were as low as 23-mid back in May 2020 on Markit.

After the onset of the first lockdown in spring of 2020, Matalan completed a refinancing exercise in and implemented a scheme of arrangement to raise extra liquidity. Shareholder and founder John Hargreaves exchanged GBP 50m of his stake in the subordinated bonds for PIK shareholder notes with the remaining GBP 80m of cash interest-paying bonds also switching to PIK. Matalan’s cash position last summer was further boosted by GBP 25m from CLBILS and GBP 25m bondholder support through new money from the 1.5-lien bonds.

Shareholder John Hargreaves could equitize his second liens holdings while other second lien holders could roll their claims into part of a larger new first lien note or the company could use some of its cash on balance sheet to redeem the remaining second lien notes, the first buysider noted.

“There could be a ratings upgrade depending on how any new deal is structured. If a favourable structure with the subs, this would boost the outlook for the capital structure and mean an upgrade for the first liens,” the first buysider said.

A partial equitization of the subs is needed and the shareholder loan could be converted into equity as the shareholders are equity holders anyway, the first buysider continued. “They could then rollup the remaining GBP 79m into a new senior secured part while they have surplus cash to pay off some debt,” he pointed out. “The subs offer over 20 points upside.”

“The [Matalan] bonds are still not pricing in a refi – they may have to put some equity in but the second liens are small so if they take out the second liens with an equity injection then they are looking good for a refinancing,” the third buysider said. “It’s another Douglas.”

German beauty retailer Douglas completed a large refi based off of a heavily adjusted management adjusted EBITDA figure and with the aid of a shareholder equity injection. Its subordinated bonds had also previously traded at heavily distressed levels.

Given low leverage the second liens can be taken out with a full refinancing, the third buysider continued. Douglas’ second liens traded at stressed levels before the refi and the equity injection helped them take those out at par. In Matalan’s favour, the company also has a cleaner EBITDA number than Douglas with less adjustments.

“Matalan’s capital structure is too expensive. The subs are covered but that is not the issue, they can lower the amount and refinance it,” the first buysider said. “If the shareholder wants to exit, and there was previous talk of an IPO, then this has to be factored in to getting a less expensive capital structure.”

Management had told investors in roadshow investor meetings back in FY13 that the company could consider an IPO should [IAS 17] EBITDA reach GBP 110m-GBP 120m, as reported.

Summer of ‘09

Independent special situations firm Sarria noted that back in October they got the sense that management was “low-balling” [guidance], having highlighted their struggle with inventory and the timing of logistics. “Inventory was going to be in the wrong place at the wrong time – again. We held our positions, but had taken down our estimates in response,” Sarria said. “Now of course management can say look at the strength of our franchise. Still, you can’t hold it against them.”

The company has previously commanded a large price-tag. Matalan in 2009 received an approach from CVC to take over the company with an asking price of GBP 1.5bn, according to a press report.

“Matalan are somewhat anti-cyclical and have a track record of outperforming in crises. Last time in 2009, before the cotton spike, CVC even came with a GBP 1.5bn bid at 10x,” Sarria continued. “It’s a great performance any way you look at it. The subs are 3.5x leveraged on our math and are par paper.”

Matalan declined to comment.

by Adam Samoon