ASDA - A few tweaks
All,
Please find our slightly amended analysis here.
Having only initiated coverage of ASDA a week ago, little has changed in our analysis post the release of the Q2 results earlier this week. The numbers support our thesis that the operational environment is improving slowly. Food and other cost inflation (pay, energy and fuel) are slowing down. Volumes are up, but market shares will be volatile for a few quarters. Progress is also being made on the EG forecourt transaction, but the Competition and Markets Authority (CMA) could still delay completion and require some disposals.
Investment Considerations:
- We took a position for 5% of NAV in the 4.0% Sep-26 SUNs before the Q223 results were published, which came out this week. ASDA has less leverage than Morrisons and has a better market position. We expect to see a sustained recovery in volumes and margins. Our valuation for ASDA of £7.3bn - £7.5bn would leave debt fully covered with equity of £1.6bn. The results supported our thesis for the company.
- Our valuation of the company has not changed with these results, we will review again after Q3
- As inflation is coming down and the gap between CPI and food inflation is beginning to narrow, all UK grocers are being cut some slack and can mend their ships after the recent increase in competition between them.
- Asda is cash generative, and once the IT CapEx is complete it will be able to cover these expenses and higher interest, leaving us confident about future refinancing.
- Like Morrisons, ASDA has significant freehold assets and can use S&L transactions to release cash for price support if necessary.
- It has a maturity wall in 2026, but by Sep-25 its EBITDA and cash flow should have improved significantly as volumes and margins return with inflationary and cost-of-living headwinds reducing.
Current Trading 23Q2
- We are not changing our projections yet. The results support our thesis of an improving operational environment and outlook for ASDA. Revenue is growing, and reducing cost inflation and price support requirements will help margins improve during H2.
- Revenue: Food revenue was broadly in line with our expectations. For the first time, Arthur Food Stores (Arthur) was consolidated. We estimate revenue includes a contribution of around £200m from Arthur. ASDA volumes were up 3.5% in the quarter. Management expects sales growth to moderate slightly in H2. Fuel revenue was £721m vs our estimate of £1bn, which was below our expectations, driven by lower prices. Revenues have been lower across the entire market. The lack of data on litres sold is deliberate, as none of the supermarkets wants to let light into their fuel margins.
- Margins: Gross profit of £721m exceeded our £715m estimate. Whilst prices are falling at the pump, gross margins in the fuel business remain higher than previously, according to motoring organisations and the CMA. Food margins are improving, albeit slowly. Gross margins continue to be further hampered by ongoing price investment. EBITDA was £238m vs our estimate of £200m, but around £22m of that difference is down to Arthur now being fully consolidated rather than an adjustment to EBITDA. Lower than we-expected rises in SG&A costs are the reason for the other £11m.
Some tweaks to our model, but nothing major:
- The tweaks to the model have only a minimal impact and have not changed our valuation for ASDA.
- Working Capital: Inventory build-up in Q2 meant that working capital was higher than we had modelled. ASDA expects this to reverse in Q3. Q2 WC Inflows were +£16m whilst we had modelled for +£66m. We have now upped our expected Q3 inflow to £107m from £66m.
- Capex: We have tweaked our capex upwards to reflect company guidance of £350m this year with some backloading. We model that this will hold into 2024 too. According to management, Capex of £300-£400m pr annum is the norm. A figure of £350m would still equate to only 1.2% vs >2% at competitors. We expect upward pressure on capex over time. However, customers will remain focused on price over store decor for some time yet.
EG Forecourt transaction still expected to close in Q4:
- Approval from the CMA is likely to require the disposal of some assets. A CMA approval process would also cause slippage in the Q4 closing estimate.
- The £650m sale and leaseback transaction is substantially complete.
- The £440m ground rent deal is expected to close in Q3
Arthur Food Stores now consolidated:
- The impact of the Arthur asset disposals is in line with our expectations, so we are not altering our projections for the combined business.
- Now approved by the CMA and consolidated for the first time this quarter.
- The impact of the Arthur asset disposals is in line with our expectations so we are not altering our projections for the combined business.
- ASDA will use the expected £20m - £25m in proceeds from the CMA-mandated asset disposals to reduce the £177m outstanding on the Arthur Bridge Loan. The remaining £152m will be paid from operating cash flow before year-end.
- Post disposals acquired EBITDA is now £48m vs £55m and Synergies are £18m vs £20m.
- Capex on rebranding the Arthur stores is expected to be £14m over the next 12 months.
Project Future, Expenses will continue into 2024:
- The implementation phase continues and H1 expenditure was in line with expectations. Expenditure in H2 will be broadly the same (£126m in costs, £29m in capex) => £250m in costs and £60m in Capex. 2024 will see some tapering off
- ASDA management says year 2 (of 3) in Project Future is making good progress
- in H2 SAP implementation is the priority starting with Finance.
- Arthur will use the EG technology platform so there will be no impact on Project Future.
- Total spend on Project Future in 23H1 was £155m. (£126m of expensed costs, £29m Capex)
I look forward to discussing this with you all.
Aengus
T: +44 203 744 7055