Iceland - inflationary pressures
All,
Please find our updated model on Iceland here.
Iceland, with its well-signposted cost pressures combined with the impact on the business of a return to the (hopefully) pre-covid world, ensures that it remains a very topical name. There are several items in the negative column for Iceland, but despite that, we are not taking a short in the name. Iceland is an extremely well-run business, a significant alignment of interest with the business 100% management-owned, and no near term maturities on the horizon. Additionally, the business is likely to benefit if consumers trade down due to food inflation.
Quarterly results:
- We track a sales per store metric, and although Iceland’s Q322 sales per store were down 3% versus Q321, it was up 12% on a 2yr metric. This is a stronger performance than we expected and has led to higher EBITDA. This was in line with the Company guidance.
- Working capital inflow was lower than we expect, but we caution on drawing any inference on Working Capital movements on specific quarter ends. Iceland’s quarter ends are not static (i,e. not at the same time of the month) and this leads to movement in working capital than is explained by timing.
- Notwithstanding that, Iceland did carry c.€20m more stock into Q4 than “normal”. Iceland management did assure investors that this was temporary, and has already been worked through.
Inflationary Pressures:
- It comes as no surprise to investors that Iceland is expecting to come under more inflationary pressures during the calendar year 2022.
- Energy costs are the number one pressure. Iceland, given its frozen nature, has a higher energy consumption than its competitors. Iceland is normally 50% hedged for their energy consumption, but for FY23 (from March 22) they have no hedges in place. Richard Walker has mentioned in the press a £20m hit, but the expected hit could be in the £30-40m range.
- Supplier led inflation: Given Iceland’s small market share and lack of own-label ambient product, Iceland has limited pricing power against branded suppliers and acknowledge they will have to absorb the cost inflation pushed through.
- The third inflationary pressure Iceland have is wages. Iceland wage bill is £430m, so a 5% increase is £20m hit, similar to energy bills.
Outlook:
- Despite the cost pressures above, Iceland are likely to report in June a modest deleveraging for FY22 (quarter ending March 22). However, we expect a contraction in gross profit margins during FY23, pushing leverage up modestly.
- Management has guided to a €10m working capital outflow in Q4, which is lower than the €30m we expect. This line item will be the difference between our expected 5.0x leverage at year-end versus Iceland’s expectation of an improvement from the current 4.9x. Either way, it is modest and subject to timing.
Positioning:
- We are not taking an active position in Iceland, but continue to monitor the situation. We are not inclined to short Iceland despite the inflationary pressures they are under.
- We are not taking a long position in Iceland at 7% yield because of lack of positive catalysts in the short term and to two non-Company specific issues, namely an excess supply of UK food retailer issuers in the Sterling High Yield market (eg. Morrisons and Asda), and low coupon/duration on the name.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
M:+44 7786 705 806