Iceland - Boring as usual.
All,
Please find our updated analysis of Iceland post its Q3 numbers here.
This update is a little delayed as we awaited some confirmation on differences between FRS102 and the now new accounting standard IFRS. The answer is as boring as it sounds, but either way of accounting for Iceland’s EBITDA, cash flow always remains the same. For Iceland, cash flow conversion remains high and supports Iceland’s credit metrics.
Investment Rationale:
- In July, we rotated our long position from the Iceland 2025s into the 2028s at a 16-point differential (exiting 25s at 97%, buying the 28s at 81%) on the expectation a refinancing would happen. It did happen, but not exactly as we had expected, our base case was the new bond would extend beyond the 2028 maturities. However, despite being the longest-dated maturities, we retain our 5% long position in the bonds (up 5pts plus carry).
- We had previously modelled that the Company would not meet its £176m+ EBITDA (FRS 102) before the Company acknowledged on the Q3 call this was going to be difficult to achieve. Therefore, we are not changing our model and expectations of £171m with leverage ending the year at 4.0x, in line with Company guidance.
- With energy prices and no upcoming maturity wall we don't see any issues for Iceland in the coming quarters. The name is trading on a relative value basis and although we maintain our position, we can foresee exiting for other opportunities.
Trading opportunity:
- We remain invested in Iceland but we are conscious that there is no longer an event on the horizon. Iceland are likely to perform in line with the market, and although we view fair value to be 7-8% range for Iceland’s 2027 & 2028 maturities, which implies c. 5pts of upside from current levels for the 2028 bonds. However, we don’t see any idiosyncratic risk in the name.
- We are likely to remain long in the FY23/24 results, due in July, but if bonds continue their recent trajectory, we may exit the position.
Guidance:
- Results for Q3 were as expected. Sales are £20m lower than our model, but Gross Profit and Operating cashflow are in line. Gross Profit margin is up 2 percentage points to 5.2% YTD versus the prior year, reflecting top-line sales of 5% growth, energy reduction offset by some investment in price.
- We were a little disappointed that the Company hadn’t bought back some of their 2025 bonds, especially given the cash on the balance sheet exceeded £140m. The company have stated they wish to reduce Gross Debt before year's end (March).
- Management has guided towards the £170-176m EBITDA range (FRS 102 basis, post lease payments), which would be one of the strongest performances of Iceland in recent years. What is more important is the Company is recommencing its store expansion plans, with 15-20 new stores planned in the FY24/25 financial year.
- The Company have guided to less than 4.0x leverage at year-end, despite some cash outflow associated with its new Warrington depot, which will commence deliveries in 2025.
FRS 102 and IFRS EBITDA
- The boring stuff. We had struggled with the differential between the quoted FRS 102 EBITDA and the reported IFRS EBITDA YTD numbers quoted by the Company and had asked for some clarity. Iceland have reverted with an answer of sorts, stating "Under IFRS, EBITDA fluctuates by the timing of payments which are smoothed under FRS 102. In addition, we receive capital contributions which are netted against capex under FRS 102 and amortised; under IFRS, these are netted against lease payments”.
- The second part of that statement in part answers our question as we had thought the lease payments to be low versus historic.
- Our model is based on historic FRS 102 accounting standards. Unfortunately, for me, we will have to change the model to the new format, once we receive the FY23/24 accounts in July.
Happy to discuss this.
Tomás
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk