(Debtwire) Matalan sustains liquidity buffer but unwind expected while lockdowns provide earnings headwind

18 January 2021 | 19:42 GMT

Matalan delivered a robust set of 3Q20/21 earnings for quarter end 28 November despite store closures that month as online business boomed and a reduction in markdowns supported gross margins despite like-for-like (LfL) sales declines. The UK-headquartered fashion retailer also had GBP 187m of cash post-quarter month end-December. However, there could be an unwind in 4Q while the latest lockdown makes January and February trading challenging, making the name risky for three buysiders, with a fourth buysider positive. 

The company this morning (18 January) held an earnings call to discuss the 3Q20/21 results. Management on the call included CFO Stephen Hill, Executive Chairman Steve Johnson and Chief Commercial Officer James Brown (a former Sainsbury’s executive) with former CEO Jason Hargreaves last year stepping down after seven years in charge. 

The quarter had resilient September and October trading, which helped Matalan deliver an IAS 17 EBITDA (pre-IFRS 16) of GBP 28.8m for the quarter, down just 14.5% YoY even though all its stores were closed by early November. November was a tough month with lockdown closures removing GBP 69m of sales from 3Q20/21 though there was 68% online growth YoY in the quarter. 

Margins were partly rescued by a 40% YoY reduction in markdowns for the quarter. There was a 22.5% YoY like-for-like sales decline for the quarter though full-price sales had a smaller 13.8% YoY decline. September LfLs were down 7.6% YoY with October down 8.9% and November down a whopping 48.0%. 

“This retailer has had an obituary written for it a number of times but it still survives so there is demand in the brand even if it is not so relevant for people living within the M25,” one buysider said. “I’m cautious but more optimistic after these results.” 

The 3Q results outperformed some investors’ expectations, a second buysider noted. “4Q is anyone’s guess. This name is a modelling nightmare,” he added. The business could still run out of cash in 2022 although the latest results have deferred the scenario by six months, the buysider said.  

Matospheric leverage 

Despite the robust earnings, Matalan is heavily levered given the exceptional circumstances which have decimated its LTM EBITDA. Matalan at 3Q20/21 had an LTM adjusted EBITDA of just GBP 1.7m, a far cry from the pre-COVID GBP 80.3m at FY19/20 and FY10/11 EBITDA of GBP 153.6m. 

Net leverage is therefore a stratospheric 215x based off GBP 1.7m LTM IAS 17 adjusted EBITDA – and 8.5x on IFRS 16 numbers, according to Debtwire analyst calculations. The company requires an around GBP 50m LTM IAS 17 EBITDA to return to positive free cashflow generation though minimal investments could hamper earnings further. Matalan for upcoming years can expect around GBP 10m maintenance capex (with an extra GBP 8m growth capex planned for its Knowsley warehouse online picket sorter), GBP 35m cash-pay interest and minimal cash taxes. 

Positively, Matalan has healthy liquidity currently with a GBP 184.9m cash balance at quarter-end 28 November which increased to GBP 187m at end-December post-quarter. Matalan at 3Q20/21 quarter-end had just GBP 2.4m unused of its GBP 50m revolver given a GBP 7.5m draw for letters of credit, GBP 8.3m for guarantees and GBP 31.8m in overdrafts. 

Management guided on the earnings call that the GBP 184.9m cash balance benefitted from rent and HMRC payment deferrals, as well as negotiations in supplier terms but that there could be a possible GBP 50m unwind of cash in 4Q20/21 versus the end-November cash position, meaning liquidity will reduce next quarter, with an additional GBP 21m unwind from monthly rent deferrals. The cash outflow in 4Q20/21 will unwind due to a number of factors, including payment of deferred rents and HMRC payments plus negotiated supplier terms will reverse in the quarter. 

If it can maintain gross margins, then the decline can be drawn out, the second buysider noted. “Margins in retail are hard to model and are fine when the company is doing well but can then be manipulated as companies buy different items or run light on inventory and not have a sale,” he said. “Also, the company will have to pay rents eventually and low rents have supported the business historically.” 

Matalan had a good quarter for gross margins with 49.8% gross margins for 3Q20/21 comparing favourably versus 46.8% at 3Q19/20 and 45% gross margins at FY19/20. 

“The performance for 3Q was decent but 1Q21 for every retailer will be tough,” the first buysider noted. “Traditionally it is a big clearance quarter even if it is seasonally small and though they refresh collections it is hard to know if people will shop again with an issue also on rent deferrals with [UK fitness club operator] Pure Gym a good example where you can only defer for so long,” he added. 

The company on 18 December completed a sale and leaseback of its Head Office property in Knowsley with proceeds applied in prepayment and cancellation of part of Matalan’s GBP 25m revolver provided as part of the Coronavirus Large Business Interruption Loan Scheme (CLBILS) and part of its pre-existing GBP 50m revolving credit facility. Around a third of the proceeds will go to prepay the CLBILS facility and two-thirds to the revolver, management noted on the earnings call. 

3Q was better than expected but going forward management needs to apply the GBP 190m cash to plug GBP 100m less turnover, GBP 70m deferred payments and fresh working capital requirements for Easter, according to independent special situations firm Sarria. 

“Management have done an impressive job and it is like [German fashion retailer] Takko in that sense, although Matalan have gone through a restructuring and established communication with CVA landlords which Takko have not. Matalan's whole remaining debt stack will need to be refinanced in 2022, which does not leave a clean 12 months to show performance.    

“Post pandemic this should be a GBP 80m-100m EBITDA company again and it's not overly levered on that basis,” Sarria continued. “Give it time and they will be alright. Nobody gains from pulling the plug. If you take a long term view, the first liens continue to be covered, but the second liens might be testing [shareholder and founder John] Hargreaves’ resolve one more time.”  

Lockdown limbo 

The outlook for 4Q20/21 trading looks tough given the outlook for earnings in the face of the latest lockdown. Stores started to close in the quarter from 19 December and by 4 January all stores were closed. This impacted December sales, which were down 10.7% YoY on a LfL basis though there were GBP 27m of online sales, which were up 84% YoY and represented a bigger YoY growth than November.  

January and February will be tough with GBP 100m of total sales across the two months usually planned. The company has mothballed 56 of its stores (furloughing all the stores’ staff), kept click and collect only at 85 of its stores (with a handful of staff) and kept the remaining 90 stores for click and collect and also picking online orders.  

The company has also booked GBP 14m one-off gains from FX trades which will show in FY21/22 though there will be a GBP 12m impact from underlying new trades which are in a deficit driven by the hedge rate of GBP 12m which will mean a GBP 2m EBITDA net hit overall. 

Matalan required a scheme of arrangement last year to raise extra liquidity. Shareholder and founder John Hargreaves exchanged GBP 50m of his stake in the subordinated bonds for PIK shareholder note with the remaining GBP 80m of cash interest-paying bonds also converted into PIK in a scheme of arrangement approved on 20 July last year. Matalan’s cash position was also helped by GBP 25m from CLBILS and GBP 25m new money from the 1.5-lien bonds. 

“The subs are toast and should be lower. Most restructurings are pre-pack without recoveries for investors further down the structure,” according to the second buysider. There could be a total of GBP 100m net working capital unwind, accounting for all deferrals in 4Q and beyond, and to get to a higher EBITDA capex will have to go up, consuming cash and leaving no free cashflow, he noted. The company could survive but it is not investible unless someone with deep pockets takes control, he added, arguing the 1.5 lien bonds could be the pivot security for a restructuring with this business needing to lose GBP 100m of debt. 

Matalan’s B3/CCC- rated GBP 347.8m 6.75% first lien secured 2023s moved two points up following the results to 77.25-mid with a 21.0% yield, according to Markit. The Caa3 rated GBP 130m 9.5% second lien secured 2024s are indicated a half point higher to 39.375-mid with a 50.7% yield. 

“Buying the bonds is taking a punt on the first liens and closing eyes but given the upside/downside one could make a case,” the first buysider said. “But for being involved in stressed retail I’d prefer [German beauty retailer] Douglas which has a better sponsor.” 

“This is a distressed capital structure and it is hard to see them growing out of the problem,” according to a third buysider. There could be pent-up demand in 2H21 but it is a big leap to see a straight refinancing, he noted. “Historically they have had challenges and the pandemic bought it to the fore.” 

Matalan declined to comment.

by Adam Samoon