Matalan - what now? - positioning
All,
Please find our slightly updated analysis of Matalan here.
The retailer has done phenomenally well in the last year to turn around its business from the lows of 2020 lockdowns. However, now that the market is indiscriminately looking to short or exit all retailers, its natural competitive inflation hedge counts for little. Just as the small 2020 facilities begin to mature, the market is closed. So at a time when the company still has more cash than ever, and performance is still improving, where is that refi deal and what is the solution?
Cash:
- The uniquely impressive cash figure of £183m per Q322 will have to pay for some £50m in WC outflows, leaving some £130m on Balance Sheet.
- As we are approaching maturity, some £70m would then be used to pay down the various super sr. and 0.5 lien facilities, leaving £60m on balance sheet, a number Matalan can comfortably operate on.
Maturities:
- The three facilities: RCF, CLBLIS and 0.5 Lien mature in July, which is why we (and everyone) expected a refinancing early this year.
- The bonds need a solution by January 23.
- So if required (and it looks like it) Matalan have the cash to address their WC outflow and pay down the super sr. facilities to roll the dice on a better market in H222.
- Before John Hargreaves accepts an all too ugly deal, we expect him to do that. Perhaps he can negotiate a short extension of the RCF to keep appearances, but Matalan surely would not actually have access to it.
Performance:
- Matalan are probably about to show a £100m EBITDA, or something close to it. This is an impressive turnaround from the retailer, even as it includes a number of one-offs.
- Business Rates and rent holidays have come to an end and present a headwind of up to £10m.
- Stock provision unwinds artificially raised Q221 by just under -£10m.
- NEW - Sterling drop: The company is well hedged, but typically adverse FX movements do feed through after a year, even if in theory the goods were hedged at the time.
- NEW - ISH: Inflation has spiked significantly higher than what we envisaged when we spelled out our refinancing thesis. This does not have to be only negative for Matalan. As regards COGS, the company benefits from long lead times in this situation, which means its competitors must lift prices first. With respect to staff cost, the rise is in part offset by the introduction of the pocket sorter late last year but clearly represents a headwind.
- Overall, we model Matalan’s EBITDA dropping back to £75m after Q122.
- CapEx plans would have to be dialled back significantly again.
Deal Space:
- The SSNs are now rated CCC+, which makes any expansion to include the 2LNs effectively impossible.
- In the current market, low Bs / high CCCs trade wide of 9% YTM. Allegedly, that is the yield that already failed earlier this year. A full refinancing at this cash cost does not work for Matalan - never mind there is no demand in the market.
- Matalan have enough liquidity to postpone a restructuring until the second half of the year. However, we currently have no reason to rely on a return of a significantly better market by then.
- We understand that a deal proposal earlier this year included an equity contribution from the family. We do not know if the loss of their tax litigation limits their ability to inject such cash in alternative ways.
Scheme of Arrangement:
- Upon closer inspection, a cram-up is unlikely to find a lawyer willing to stand in court for it. So unless the family pull a rabbit out of their hat, it’ll be either a cram-down or a hand-over.
- A significant involuntary impairment of the SSNs seems out of the question, except for a hand-over or administration scenario.
- We think there could be a deal whereby SSNs are offered a 15% cash + 85% stub and an opportunity to inject fresh cash super sr, a) to pay for any expenses and b) to put the cash back into the business that paid down the 15% in the first place (different investor composition).
Fundamental:
- In the downside case of being handed the company, We think the SSNs would drop 10 points and the 2LNs would tank down to nuisance value (not the only scenario in which the latter do that). At approx. £300m Matalan would be historically cheap and in our view an opportunity to double investment or more over some 3-year horizon (no XO CapEx or fresh cash required). In that context, the 10 points temporary downside appear peanuts.
- If that sounds too good to be true, it probably is and the family will fight for it, only give up minority equity, if that.
Positioning:
- We are selling our 2LNs at 74 p/£. We continue to believe that Matalan will find a solution here as in our view the company should be able to rebuild its EBITDA, but where there is no demand in the market, we would not want to be buying the Jr. position at such a high level.
- We continue to hold the SSNs and will probably decide to build out the position. We see Matalan as a good company with a bad balance sheet - and in a bad environment. From a medium-term perspective, at less than 4x EBITDA through the SSNs and just over 5x through the 2LNs, we consider Matalan a basement bargain and would love to own the company here. However, the market is now requiring very high yields from this sector and the current outlook does not provide for that. Even the SSNs may have to temporarily drop a little further, but on the current position, we would be willing to wear that if it comes.
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003