ASDA – Support
All,
Please find our slightly updated analysis here.
ASDA’s operating performance is strong despite the continuing headwinds from cost inflation and consumer confidence. We expect gross margins to be under some pressure in 2024 through higher wages and the impact of price support. Notwithstanding that, we expect leverage at the end of 2024 to be around 3.4x (vs 4.0x at FYE23). With our forecast interest cover by 2025 >3.0x and leverage at 3.0x by September 2025, ASDA will be in a strong position for a refi ahead of the SSN Maturity a year later. We are maintaining or long in the 2027 SUNs, which we expect will be refinanced at the same time as the SSNs.
Investment Rationale:
- We have a position for 5% of NAV in the 4.0% Sep-26 SUNs before the Q223 results were published. The trade has so far not done much; our entry price was 91.6c/£, and the bonds are quoted at 91c/£.
- 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 the Q4 results, and we expect the bonds to improve as the benefits of the Arthur and EG transactions flow through.
- 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 program 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 September 25 its EBITDA and cash flow should have improved significantly as volumes and margins return with inflationary and cost-of-living headwinds reducing.
23Q4 was strong, but we still expect price support to continue into 2024:
- Revenue rose 9% to £6bn, largely down to the consolidation of the Arthur Stores business. Organic growth was 2.2%. In a very competitive market, EBITDA margins continued to increase in the year reaching 4.5% in Q4. We expect some of this to be given back to customers via subsidies (and lower gross margins) in 2024.
- Operating Cash flow was £626 vs £460m, EBITDA was £120m higher (£327m) and working capital inflows were nearly £60m higher. Management has promised to generate £500m from working capital (by sweating its suppliers). There will be pushback, but ultimately ASDA's suppliers will either sacrifice margin via worse terms or lose business.
- In 2024 ASDA has launched and expanded its price matching with Aldi and Lidl and has added 900 items to a Price Drop programme. We understand the logic but expect some headwinds for gross and EBITDA margins in 2024. The discounter’s market share wins have peaked, but we expect the need to win back customers (and volumes) will continue to require some price support. Management at Morrisons has commented that fuel gross margins are slowly falling back, and we expect the same will happen at ASDA. Overall, EBITDA will be higher on the additional volumes from the assets acquired from EG.
- We will update our model after the FY23 accounts and the 24Q1 Trading statements are published.
I look forward to discussing this with you all.
Aengus
T: +44 203 744 7055