Beyond Black-Outs / Risk Summaries

All,

Black-outs in Germany should be over by February and consumer confidence / disposable income will take time to drop to the point we will be pricing in by Christmas when we get more reliable readings. Soon the world will have had nine months to adjust to the war in the Ukraine and, unless there is a significant turn of events, we’ll settle into the new reality - lower - probably somewhere between now and Christmas. Therefore, even if we have no target levels in mind and leaving some room for said black-outs, we think it’ll be time to put risk on again before the year is over.

So in an effort to remind us all of the remaining moonscape of corporate credit opportunities in Europe, we are outlining our ideas and their risks and drivers in one list below. Some are attractive now, some should become attractive soon, but we think it’s probably a good time to start looking around again.

For more information and to see our positioning, please log in to our website. On the main page under Risk Summaries, all names marked with a 📕 are currently on our virtual book. The current book and our track record are also available for download.

Adler: NR

The Consus convertible is small and illiquid, but is indicated around 75c/€ only 9 weeks ahead of maturity. Maturity is coming too soon to be threatened and these bonds should trade at par for any variety of reasons.

ARE23s at 84c/€ have a good chance of making their 20% + coupon upside in the next six months if X-holders take the opportunity of buying ARE assets for the same amount and leapfrogging existing bonds at that entity. It is in the interest of the X-holder Group to keep Adler out of a StaRUG scheme. Their downside lies in the 60s, but we are increasingly confident that won’t happen.

ARE 24s and 26s are value-covered in virtually any scenario, but could face a threat from intra-group sales of assets in the context of cashing out the 23s that would leave ARE with only its shares in Brack and a mere receivable for what so far is still its own resi book.

ADJ bonds around 60c/€ deliver a YTM of 16%, but are not really a YTM consideration. Instead, creditors need to be prepared to drive Adler’s refinancing/restructuring. Bonds are also value covered, but when applying a 15% discount to the ADO resi portfolio alone and after accounting for the bank liabilities on it, this gem of a portfolio only covers some 45c/€ with the remaining value coming from its shares in ARE and - yes - Consus. Upside comes from a faster sell-down from a more varied portfolio of assets, while risk at this level comes from potential shareholder litigation ranking sr. unsecured at ADJ.

Aggregate: NR

The SUNs are indicated around 40c/€ on the expectation that the company defaults, if not on its covenants, then on payment. A default would require significant cash to retain control over the various assets, while on the upside, value coverage in a going concern should be 70c/€ - rising in time with %age of completion.

Following Agregate’’s deal with Vivion, the Fürst asset remains under control and book values on the remaining QH and Fürst assets can likely be maintained. We expect Aggregate to also be able to take care of the VIC bonds from these or similar proceeds, which should take care of most current triggers. If so, provided Aggregate continue to sell some assets to fund ongoing interest payments, assets have three years to fully grow into the capital structure, which remains unlikely at this time, but together with proceeds for minor assets provides some further upside.

Aston Martin CCC

The First Lien yields 9.5% a reasonable return we would expect 11%+ return over the next 12 months with 9.5% in yield and 2 points in capital gain now the successful execution of the capital raise has hugely reduced liquidity risk through the maturity of the bonds. Around EUR325m of the EUR650m proceeds will be used to buy back debt, we expect it will be the SSNs. The AML brand has significant value and in a future sale to a larger OEM should be attractive enough to keep the bonds whole. On the downside, Aston still needs to execute on the launch of new GT/Sport models over the next two quarters, however, it now has ample breathing space. Also, H1 results were impacted by working capital issues that will not reverse in the short term, bond yields will still be volatile, particularly when the promised Q3 reversal of working capital outflows is delayed.

Accentro NR

We are not positioned. Accentro’s attempt to change its strategy looks to be failing. The company doesn’t have the money to complete the refurbishment of the East German-based investment properties it has. Despite the Mar-23 bonds trading at 55c/EUR the company is not communicating with creditors and the SUNs are unsecured and will be structurally subordinated to bank debt at the property-owning companies. We remain concerned about why these assets were bought and whether they were only ever meant to be temporarily parked with Accentro. Potential downside to a short is the possibility that Cervat Caner fresh with cash from Aggregate may intervene to facilitate a refinancing by taking away the East German Investment assets.

Boparan B-

Around 70p/£, the bonds trade on a wide yield basis of 20%+ and CDS to June 23 pays 17pufs. Our base case is that Boparan will remain a going concern and will pass through the costs as required. If Boparan would break their minimum EBITDA covenant, we would expect the banks to re-set it, waive it, do anything but trigger a default. We think the company has sufficient liquidity too.

What gives us confidence is that Boparan has a very transparent cost structure. If the supermarkets wanted to push Ocado over the edge, they’d gain nothing, but an administrator to deal with.

As our long December CDS position is set to expire, we will be looking for the right profile of exposure.

Casino B

Shorting the 24s offers 40 points of downside into a Sauvegarde. Without further asset sales, which we can’t see in the short term, Casino will probably breach covenants in Q1 2023 and any subsequent entry into Sauvegarde would see bonds drop to 20-35c/€.

Upside: Except for the 23s, without clarity on upcoming covenants there is limited upside. 5-10pts relief rally post passing Q3 covenants is possible, but the focus will very quickly return to the next crunch point: Q1 2023. Bonds are increasingly factoring in a chance of Sauvegarde, but investors can pair shorts with CDS, or a longer-dated / lower €-value bond.

Upside would be provided if further large asset sales are announced, or if J.C. Naouri can find some other kind of deal.

CGG CCC+

We see potential upside for the $ notes as the more robust operating environment flows through to the bottom line which will push the bonds back into the 90’s. $8.75% notes are trading at 88.7c/$ and the €7.75% at 89.4c/EUR. The notes traded above par prior to the Ukraine conflict, albeit that would be a stretch for a CCC bond now. On the downside, the CCC+ rating caps that upside for now. Oil prices are still elevated but have fallen despite the ongoing Ukraine conflict, however, our analysis points to increased CapEx spending enhanced by new E&P as part of energy security plans which will benefit CGG.

CMA CGM BB+

The SUNs currently yield under 6% trading at 104.3, this is a name to go short when the cycle turns but not just yet. 2023 is looking increasingly challenging with significant shipping capacity being delivered at a time where trade may also be hit by recession. Port capacity and other logistics bottlenecks are also easing putting downward pressure on box rates and the impact will start to be seen in results from Q4 and beyond. The Q4 results should be a point to enter the short trade. The yoy results will begin to weaken and the impact of re-negotiated (lower) annual box rates will start to flow through from Q1 (against very strong comps.

Douglas: B-/CCC

Yielding 11-12% to Maturity, the B- Douglas SSNs offer a reasonable spread. Away from market, we think the SSNs will also earn 5 points to 10% YTM by Feb 23 on a very strong (all important) Christmas season. Key detail: Douglas negotiate 75% of annual in-take prices during calendar Q4. So COGS inflation won’t bite until Q223 (March) and well over half of FY 2023 will trade on COGS negotiated in 2021.

On the downside, the equity story provided by THG’s 2020 IPO has evaporated and the bonds are being traded as proxy for inflation and the tightening consumer purse. The latter is what provides the opportunity now.

In retail, we see a supportive barbell emerging, where the luxury and discount segments outperform the mid-market. Idiosyncratic tailwinds come from a significant rationalisation of its store base, which in conjunction with the feathered inflation inset has us ultimately forecasting a drop in leverage by 2.5x over the next 12 months (shockingly).

The PIKs are also attractive in our view, but have full downside and are beyond the pale of most market participants, which should see them lag the SSNs in recovery for a while. There are no triggers in sight.

Frigoglass: CCC

At 55c/€, the bonds increasingly offer 20 points upside to Easter 2023. Bonds have been trading at this level since June and reflect the tight liquidity situation outside of Nigeria. On the downside, margins are under pressure like they are in every business and we see the need for some €50m fresh cash - even after receiving generous insurance proceeds. Let’s assume that enters sr. to the bonds.

Timely execution of reconstruction in Romania would be key. As the summer season comes to an end, so does demand for the impaired ICM division. A sudden closure of Russia’s borders to the west would cause far less damage now than it would have only two months ago. So in our simple minds, this increasingly buys Frigoglass time until February to replicate its burnt-down Romanian operations and serve the market out of E-Europe again. Presto, we’d be looking at Frigoglass from a yield perspective again and 75c/€ would still leave 25% YTM then. Further upside could come from energy-efficient cabinets and the fact that the family controls the largest customer - can manage margins somewhat.

Iceland B

Upside: Bonds have 5-6pts upside at a minimum, as bonds should trade within a 10-13% yield range. Market is too pessimistic. Iceland has high cash balances, no upcoming maturities and limited debt in front of the bonds. Iceland will benefit from consumers trading down and ironically have seen an increase in demand for their premium lines as new customers come to Iceland. Frozen food will continue to outperform in recessionary times, further boosting the macro picture for Iceland.

Downside: The headwinds are well flagged - wage inflation, energy prices and intense competition. However, we feel there is limited downside from the 70s and the 25s are unlikely to drop into the 60’s (10pts lower) on the current set of flagged headwinds. Q1 results highlight that excluding energy costs, gross margins have actually increased and Iceland are able to maintain selling margin in this environment.

Intralot: CCC

The 24s are now yielding 8.5% - despite their CCC rating - with relatively plain sailing to look forward to in what is a dynamic industry for the #3 player in the US. In Standard General, Intralot attracted a sizeable new investor whose proceeds it has used to buy back the minority shares in its US business, which it had lost in last year’s restructuring. Following the refinancing of the resulting 2025s, everyone’s focus is back on fundamentals and growth. We may be shelving this name.

INTU Debenture/SGS CCC

NTU Debenture and SGS PIK Bonds have an equity return profile on their respective shopping centre asset pools. Our thesis of doubling our money in the medium-term now needs to be discounted at higher rates and factor in a drop in disposable income. Bonds are therefore still creating their assets at a mere fraction of 2018 peak values.

Upside comes from footfall and occupancy - each again close to pre-covid levels - and only when that has come back: higher rental agreements. Since the pandemic, the latter have been re-struck at low levels in an effort to re-build occupancy/footfall, sharply reducing overall net income at the individual shopping centres. However, with collection rates back above 90% and footfall and occupancy continuing to improve, the medium term outlook has been improving.

Downside is driven by reducing consumer confidence and increasing interest rate environment which is reducing valuations. There have been minimal large shopping centre transactions in the market and there is an underlying fear that several shopping centres, including SGS’s and Debentures’ need to change hands.

Jaguar LandRover B+

Downside: £4.7bn of bond debt with over £700m due in Q1 next year. JLR need to issue paper in the short to medium term to refinance and maintain their (large) cash cushion. Downside (6-8pts) of 12-15% yields is not beyond possibility if bond market doesn’t re-open at favourable rates. However, with the Company having significant near-term liquidity £5bn of which £3.7bn in cash, downside will be constraint. The transition to electrification is not a clear pathway. Another concern is the Jaguar brand - does it have a place given the Company has not launched a new Jaguar recently.

With yields of 8-11% the valid question is: Where is the upside? There is significant liquidity and some momentum in earnings. Near-term demand and margins are relatively secure due to limited stock in dealership and focus on the higher margin vehicles in the current environment of shortages in the supply chain.

KCA Deutag B+

Upside: Around 95c/€, yield to maturity (worst) is 12% to Dec. 2025 with potential upside from an early call. Leverage is 1.2x pre-acquisition with new PIK and equity raise ongoing. Bond documents prevent significant increase of leverage at bond level (2.5x incurrence test), protects the downside on this bond. Other downside is in relation to their Russian business, which is 25% of their EBITDA.

KCA have the wrong capital structure, with bond maturity of December 25. Wage inflation is real concern, but KCA Deutag continues to gain contract extensions.

Matalan: CCC

At 77c/€, the SSNs offer a coupon and up to 23 points to a restructuring - if an investor / fresh cash can be found. Conversely, we see up to 10 points of immediate downside in case of a restructuring, but would not expect that to last long.

It does not appear that the Hargreaves family has the means or inclination to inject sufficient sums. Thus options include an extension, which would see the SSNs yield 15%+ until 2026, or a degree of equity conversion. Fundamentally, we would love to own Matalan at £300-350m (trades at double the value in good years), but a deal would have to be consensual and minority equity could end up trapped. While Matalan has recovered strongly from the pandemic, EBITDA contains a number of one-off benefits and FX and particularly inflation provide further headwinds. Attempts to refinance failed earlier in the year and the market is much worse now.

Naviera Armas: NR

Around 104 c/€ the new PIYC bonds yield approx.10%, but come with stapled equity of just under half of the company (ensure A and B shares travel for free). It’s tough times for the ferry business, but the bonds can force a sale of the company from 2024.

The company is burning cash as it struggles with underperformance in its Strait business (following reopening after political fallout between Spain and Morocco) and - despite govt. subsidies - high fuel costs. Bonds are value covered by ships but will get layered with fresh cash for fuel. The Strait business should return towards normal next year, while Fuel prices are what they are.

Ocado B+

The SUNS currently yield 10.4% a price 79.2p/£; the 0.875% 2026 SUNs trade at 9.6%, 75.5 p/£; and the 0.875% 2026 trade 10.1%, 67.4 p/£. The upside is a potential 5-point gain from a return to a yield of 8.5% for a B+ name with a fully funded business plan. However, we see 13% as more appropriate given the equity risk (equating to a price closer to 72 p/£). Once we are looking to add risk, Ocado will be on our shopping list - probably the lowest dollar, longest duration paper. Downside, retail is enduring a tough market whilst International is still an equity story. Bond pricing is being driven by short-term concern over inflation rather than the long-term success of the rollout of Ocado’s technology platform. Investing in bonds feels like venture capital, which makes an interesting diversification to our book. There have been a number of sell-side banks that have cut their price targets for the equity, however, all still show a significant equity cushion for the bonds.

OHLA B3

We are long 4.3% NAV in the bonds and 3.5% in the equity and expect a 17% return on the position in the next 12 months. An increasing backlog will boost the equity valuation along with improving cash flow. Post restructuring, bank guarantee lines have been extended to >1year, supporting a rise in the order book. The banks should also release €140m of cash currently held as collateral. The downside, the Ukraine conflict is casting a shadow over construction (global recession fears) and the equity has fallen from €1 to €0.58. However, the post-Covid infrastructure investment funds (US/EU) are still in place.

Orpea NR

We are lacking the short-term triggers for a short, but cannot fundamentally justify a long position either. Business has significant fundamental downside, notwithstanding the conciliation protocol in May where banks agreed an additional €1.7bn of committed additional facilities that will layer the bonds.

After a decade of rapid expansion, Orpea now find themselves over-leveraged and facing significant wage inflation as well as covid-related lower occupancy rates. Even with the committed additional facilities, Orpea requires additional funding to complete CAPEX over the coming years, totalling €1.8bn, which relies on a €1,7bn arranged but not yet syndicated facility. Any failure to secure this funding could see Orpea entering Sauvegarde.

Asset disposals will provide some upside to the bonds. Orpea have committed to reducing their overall estate and the nature of the business allows the sale of a subset of nursing homes relatively easily.

Stada/Nidda CCC+

We are seeking to go long the 5% 9/2025 SSNs for 5% of NAV. At an entry price of 90c/€ we expected to earn at least 8%+ YTM with a possible quicker return to par if there was a swift end to the Ukraine conflict. The bonds have since traded down to 88.2, our thesis has not changed. Pharmaceuticals are not sanctioned and the Russian business is financed locally. Leverage 6.5x but FCF covers interest c1.6x. Nidda has €340m in cash and an undrawn €475m RCF (for M&A, refinanced via bonds). It has no maturities until 2024. An IPO was mooted in 21 but didn't materialise, late 2023 is a more realistic target date. In terms of falls in leverage the Ukraine conflict will hamper M&A this year. Downside, continued closure of the high yield market narrows the refinancing window for Stada.

Standard Profil CCC+

Currently trading in no man’s land (mid 60’s), the bond has easily 10pts of upside (which would push it back into yield territory of 15%) in the next 6 months on the back of the conversion of recent order wins to revenue, underpinned by the proportion of EV sales Standard Profil order book has.

Downside: is limited at current levels, given the lack of upcoming maturities. We calculate recovery in the mid 50’s on a depressed EBITDA level. Support likely from OEMs as they supply low cost product and there is no easy way to substitute Standard Profil. The bond is small in size and exposed to OEM production levels, and still over-exposed to VW, so any impact of energy prices on production levels will hurt.

Momentum of Q3 and Q4 numbers will be favourable. Recent numbers demonstrate that Standard Profil are achieving price increases compensating for raw material movements. Gaining traction from relationship with Tesla which coupled with increasing OEM production gives strong base to grow EBITDA from.

Steinhoff: NR

SEAG A2s are not pricing in the approx. 15c/€ (25%) upside from their recovery at NV level, nor any negotiating value associated therewith. These bonds trade in line with the depressed EV of the assets underneath them, but should be able to capture this upside in a restructuring towards the end of next year, as they will be the largest and most central fulcrum in the Steinhoff structure, sitting structurally sr. on nearly all assets outside of Africa, except for two intracompany loans, the larger of which feeds SFHG. To preserve the integrity of the group, SFHG A1s and A2s may be forced to give up value to the SEAG A2s.

The SFHG A2s look fully valued in the high 30s. At current asset values, creditors benefit from the value of said intercompany loan from SEAG worth some €20c/€ to them and from a guarantee of SHNV in approximately equal measure.

The SFHG A1s by contrast look undervalued in the 50s and at least numerically offer 60% upside on current prices. These are like the SFHG A2s, but also benefit from a third ranking g’tee out of Africa (ahead of anyone else discussed here), which is currently worth an incremental 50c/€ to them, which makes them numerically the most undervalued instrument in the structure.

Takko: CCC-

Around 68c/€ Takko bonds are once again pricing in the full LC facility as capital and are creating Takko at 5x a €100m EBITDA. Sr. facilities should be able to extend by a few months, given bonds are the fulcrum and mature in November 23. Provided existing banks and sr. facility providers will remain in the structure, Takko should require no fresh cash (like Matalan), but arguably at a prolonged period of €100m EBITDA, Takko would struggle to fund its debt / LC pile, which might, in turn, require a large D/E swap and therefore a further drop in trading values, offset by two coupons between now and then.

Throughout the pandemic, Takko has performed even better than Matalan. Still, inflation and FX are powerful headwinds, bondholders are largely organised and Apax are all out of cash.

TAP: B+

2024s yield 10% YTM, but could be refied together with the June 2023s for a 15% IRR. Over the last two years Portugal has invested over €2bn of cash into TAP, altogether junior to the bonds for 100% of equity. TAP now has the cash (and is receiving more) to pay down the 23s next year if there is no alternative. TAP are selling 18 of their slots in Lisbon later this year (to Ryanair most likely). Absent further lock-downs, TAP are now well capitalised and we see no reason for distress, even as the airline is less hedged for fuel prices than its peers. Should another disaster strike, bonds remain well protected in the opco where the licenses are held.

Tullow CCC+

10pts upside on both bonds to reduce yield to 9% and 11% (from 12.5% and 17% respectively). Overall leverage projected to drop to 1.5x at year-end, regardless whether the merger takes place or not. Expect re-rating of bonds by end of FY22 as business continues to deleverage, especially if merger completes on some terms. Further upside from any farm-out agreement in Kenya post Kenyan Presidential elections in August. In addition, although doubts remain on the completion of the Tullow/Capricorn merger, even if equity terms change the business will further deleverage from any merger.

Downside: Bonds could trade off a further 5pts but this is limited by the deleveraging path Tullow are on. Tullow’s problem is that it lacks the resources to develop several investible opportunities. Production remains the key metric, especially at TEN, which is underinvested. Recent numbers have been a little light. Another large negative is the Ghana Tax issue but to put into context this equates to 0.3x of leverage. Bonds are likely to trade off if merger completely collapses.

Upfield CCC

Upfield bonds have rallied 20pts from the low 50’s in July on the back of Q2 numbers where the Company demonstrated the ability to maintain margins.

The upside is a further 10pts to push the yields into 10-13% range which we feel is appropriate for a company maintaining its margins. There is no doubt a lag in the passthrough, but this should lead to some momentum for upcoming quarters. There is no near-term liquidity crunch and the worse appears over.

On the downside, we are unlikely to see the 50’s again. There is significant leverage ahead of the bonds via the Senior Secured Term Loans and the relative small size of the bonds is a negative. However, KKR sits behind the Senior Notes with a €1.9bn cheque so unlikely to make any early opportunistic move on restructuring.

Overall, we acknowledge the input cost pressures but remain confident that Upfield can sustain gross profit margins in the low 30’s (albeit 3-5pts lower than historic average). A margin above 30% will achieve some deleveraging in the short term as cost-cutting measures continue. Bonds are likely to recover further.

Vallourec B+

Upside: Around 96c/€, yield to 2026 maturity (worst) is 9.5%, with some further upside if called in June 23. Business is 2.0x leveraged with a further 3x of equity beneath the bond. Bond is call restraint with limited upside.

Downside however is also limited, Strong momentum from the high oil prices ensures the “tubes” business is improving. Historic EBITDA has benefitted from high iron ore prices and despite the sell off in commodities over the summer, iron ore prices are still c. $100/t. This will maintain the deleveraging track Vallourec are on.

Wrong capital structure, and expectation they will refinance the bonds at the earliest possibility.

Vivion BB+

We are long 5% Nav at 5.5% in the expectation that Vivion's cash pile meant it will benefit from any German RE crisis. So far, the trade is underwater, all German real estate is wider with Vivion 210bp wider. Management recently eliminated any Aggregate risk from the sale of the Fuerst project. We don't see Vivion’s portfolio as overvalued, but leverage is higher than investors think as the German assets are 55% owned. On the downside, Vivion is young, opaque and complex. Comvvvvmunication is patchy and investors still lumps it In with other German Real Estate companies.

Please let any of us know if you are interested in any name.

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk