ASDA – Buying Time.
All,
Please find our slightly updated analysis here.
Top-line headwinds remain for ASDA; the Future project to separate the ASDA and Wal-Mart systems is a drag on sales volumes and customer satisfaction. However, ASDA has time to sort out the kinks in its IT project. ASDA completed a refinance in May, pushing the maturity of the bulk of its bank debt out to 2029 and beyond. ASDA is pausing the IT rollout to larger stores until after the key Christmas quarter to avoid any risk of disruption. We have not changed our thesis on the company and see the current issues as eminently solvable.
Investment Rationale:
- We have a position for 5% of NAV in the 4.0% Sep-26 SUNs. We entered the trade at 91.60, and the bonds are now trading at 94.25. It has been slow going, but the trade is making money.
- Our DCF model shows a significant equity cushion below the bonds.
- There are <£750m of maturities between now and 2029, giving ASDA ample time to iron out the current issues relating to the IT rollout and to improve its market share
- ASDA has less leverage than Morrisons and has a better market position. We expect to see a sustained recovery in volumes and margins.
- As inflation is coming down and the gap between CPI and food inflation is beginning to narrow, all UK grocers are being cut slack and can mend their ships after the recent increase in competition. ASDA has more to do than some but will benefit from this tailwind.
- Like Morrisons, ASDA has significant freehold assets and can use S&L transactions to release cash for price support if necessary.
24Q3 – ASDA is still struggling with top-line sales:
- The quarterly sales and profitability numbers were a disappointment to us. Project Future has been more complex than anticipated, and ASDA has postponed some implementation until 2025.
- The recent refinancing has bought ASDA plenty of time to improve performance. The H1 refinancing has pushed debt maturities out; there are only £262m SSNs (Sep 26) and £500m in SUNS (Feb-27), with the rest being in 2029 H2 and beyond.
- The negative impact on sales will require some additional investment in pricing to raise overall food and clothing revenue again.
- In the quarter, the grocery business saw a fall of 4.8% in Q3, better than the over 5% in Q2, but still poor. Management admitted that attention had become over-focused on Project Future at the expense of customer service.
- The clothing depots are being gradually moved on to the new IT systems to ensure availability remains high (the Food availability problems in Q2 have not been eliminated).
- Smaller stores are being moved onto the new systems, but larger stores will not be moved until the beginning of 2025 to minimise disruption in the critical fourth quarter.
- Margins have fallen slightly quarter on quarter, with gross margins impacted by the lower volumes in food and additional costs in clothing due to disruption in the Suez. EBITDA margins weighed down by further pay rises and an increase in staff hours to improve customer experience.
- The new convenience business has seen a significant slowdown in rollout, and management is still testing the product mix needed to maximise margins.
- Working capital is expected to improve in Q4; ASDA expects £100m of inflows from new trade terms agreed early in Q4, with another £100 expected (some of this is likely to be reflected in 25Q1). We have tweaked our Q4 expectations.
- Capex: 2025 Capex of £350m-£370m is guided in 2024. The 2025 figure will be slightly higher with capex on some tired stores. The focus on Project Future has taken attention from some tired stores. Competitors spend >2% of sales on CAPEX vs 1.2% at ASDA we expect upward pressure on CAPEX and for the figure to approach 2% over time.
- The Employer’s National Insurance increase announced in the Budget will cost £100m from 2025. The increase in business rates will only impact from 2026, and management declined to comment on expectations. Management indicated that they would consider the impact of higher NI and Living Wage in deciding pay awards in 2025.
- We will do a full review with the FY results (in early 2025), but for now, we have updated the 2024 year in our model.
I look forward to discussing this with you all
Aengus
T: +44 203 744 7055