ASDA – Drinking from the pool. Initiation - Positioning
All,
Please find out initiation analysis here.
ASDA has faced capital structure challenges caused by the cost-of-living crisis and inflation weighing on a leveraged balance sheet. ASDA’s leverage levels are less than Morrisons, but the private equity owners have been more active in M&A activity in recent years. ASDA still owns most of its property, although the company has engaged in numerous Sale and Leaseback (S&L) deals to help finance acquisitions. Whilst there is still water in the freehold asset well, it is not infinite and ASDA will want to avoid a row with investors. The company has £3bn in maturities between February and September 2026, but we expect EBITDA and Free Cash flow to have improved sufficiently by then for a refinance to be completed. ASDA reports 23Q2 figures on Tuesday 15/8.
Investment Considerations:
- We are taking a position for 5% of NAV in the 4.0% Sep-26 SUNs after ahead of the publication of the Q223 results, due next week. ASDA has less leverage than Morrisons and has a better market position. We expect to see a sustained recovery in volumes and margins.
- 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 strongly cash generative and once the IT CapEx will give way to store refurbishment, should be able to cover these expenses and higher interest, leaving us confident in the 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.
- We need to understand better the exact amounts that are earmarked for the convenience strategy and will ask this question of management.
- Our valuation for ASDA of £7.3bn - £7.5bn would leave debt fully covered with equity of £1.6bn
Current Trading:
- Market share: In the cost-of-living crisis, ASDA suffered losses to the discounters. The market share losses have eased and are beginning to reverse. Historically, the discounters market share, ebbs as the economy returns to health. This time might be different, but there is little to indicate that the discounter model is changing. A significant investment in square footage would be needed to take on a greater variety of stock.
- Gross margins remain lower as ASDA bolsters sales through pricing support. Fuel margins are also higher.
- Operating cash flow was negative in the quarter, but ASDA experiences an inflow from working capital in Q4 which unwinds in Q1. The main swing factor for working capital is payables, which build up in Q4 and fall back in Q1.
- EG Acquisition: ASDA is acquiring the UK&I forecourt business of EG Group, with the transaction expected to complete by the end of the year, subject to approval from the CMA. Senior debt in the EG transaction is 3.9x, and leverage falls from 4.5x to 4.3x. The total deal EV is £2.7bn. The deal is less leveraging than was feared, with a £450m equity injection promised.
Ambitious and still likely to be acquisitive:
- TDR and the Issa brothers are seeking growth from the petrol forecourt /convenience store segment. The convenience rollout will continue but the annual investment is not yet clear, and do not rule out infill acquisitions to speed up the process.
- Debt markets will remain tight, and refinancing terms will be harsher than previously. The EG Group transaction is being part-financed with equity, a recognition that SSN investors are more cautious about seeing the freehold asset base reduced.
- We would still expect further S&L deals, but the level will reduce as the 2026 refinancing approaches.
- ASDA is acquiring 350 forecourts (containing 1,387 stores) from EG for £2.3bn. Funding is from £700m in secured debt, £1.1bn in S&L and £450m in equity. Completion of the purchase is planned for Dec-23, but obtaining CMA approval will be necessary before consolidation.
- ASDA acquired 132 forecourts from CoOp in Aug-22, the cost was £450m. Funding came from a £200m loan and £238m in cash; the cash element was initially part-financed by RCF drawings. Approval from the CMA came in Q123, and Arthur will be fully consolidated in Mar-23.
- The transactions are accretive before synergies. Forecourt margins are above the current 3.3% EBITDA margin at ASDA. With higher gross margins and broadly similar operating costs, this will remain, although it will reduce as the current high fuel margins fall. ASDA’s leverage will rise by <0.3x after both transactions are consolidated.
I look forward to discussing this with you all.
Aengus
T: +44 203 744 7055