Matalan - Testing Fama

All,

Please find our significantly updated analysis of Matalan here. 

I’m an alum of the University of Chicago and so - believe me - markets are efficient. Well, almost. If exceptions define the rule, Matalan should be a case in point. The retailer has gone through a terrible 18 months and the next 12 will not be perfect either. But the operations are undiminished and once management have found a new groove, so should be a ~ 10% EBITDA. Even if the cost-of-living crisis adds to the stretch that lies before us, we don’t think that should take much more than trading through two or three (half-year) seasons - at the end of which, shares should be worth well over £20, a 3x to 4x return from where we are seeing them quoted. The locus of control is all within the company itself and it’ll require nothing than a return to normality at a time where discounters are generally fairing well already.

Investment Rationale:

- Since the additional Sr. Sec. request, we are holding a 4.4% of NAV position of Matalan across Sr. Sec. Notes Tranche II, Priority Notes, 2nd Lien Notes and equity. The position is marked with a loss from last year. 

- However, we continue to feel very strongly about Matalan. The estate is undiminished and so will be earnings eventually, even if the cost-of-living crisis will have it take a little longer.

- We are holding the new pieces with a medium-term outlook and are confident the equity will turn out to be very valuable once Matalan trade through their currently committed ranges.

Current Trading:

- New management has come in from Takko and other relevant backgrounds.

- Online in particular has suffered during Q124, in what looks like sheer management failure during the tumultuous period. Matalan have been migrating to a new platform hosted by THG and things clearly didn't go smoothly.

- As forecast, the tailwind from an easing supply chain has brought support worth over £30m on an annualised basis (or 300bps).

- Early Q2 trading has been going better as management was at pains to point out, but the EBITDA estimate for FY24 has been taken down to reflect the lost revenue in Q1. 

- Stock at the end of Q1 was down 7% by volume, but up overall, indicating the increased COGS the company is dealing with this year. Management expect a clean stock position at the end of the summer and has taken measures to commence summer sale a week later than originally planned.  

Valuation:

- During restructuring, FV was estimated to be a whopping, (if understandable in the long-term) £ 586m. We don’t know the underlying assumptions that went into that case, but we don’t disagree.

- Looking forward today, perhaps more relevant then, we struggle, however, to value the company below £450m and our Recovery-Only case comes out at a DCF of £480m. 

- Only in the most short-term focused, reality-removed, desk-top-only analysis of 5x (usual distressed multiple) times this year’s EBITDA are we able to condescend to some £330m, which appears to be the basis for some of the quotes we are seeing out there (not sure how much really trades at those prices of £5 - £7 per share.

Outlook:

- The estate is undiminished at 230 stores, going to 232 by October. Q1 has been hopeless, but with management changes and restructuring under way, we should not be too surprised. Also, the merchandise has had to be acquired at an eye-watering price point, but the main underperformance has been in Sales, not margin. 

- Management have been keen to point out however, that Q2 is already going much better and present themselves optimistic going into H224. We have no problem modelling the EBITDA forecast for the year. 

- Last year’s cost headwinds of FX (£25m), Freight (£30m), Energy and now lost Sales of £50m (resulting in lost Gross Profit of roughly £25m) explain together £80m of underperformance that resulted in £11m LTM EBITDA. Each of these events is either reverting, or has already, or has likely been a one-off in the first place (the lost sales during restructuring). So we find a return to £10m + £80m = £90m EBITDA very easy to understand and ourselves are forecasting £100m EBITDA in FY25. Hence our view on valuation above.

Here to discuss with you.

Wolfgang