Iceland - Looking beyond FY21

All,

We have updated our model for FY20 and Q1 2021 numbers here. 

The Company will continue to enjoy the increased demand UK supermarkets are experiencing due to Covid-19.  Coupled with this is the rates holiday until April 2021, £10m per quarter.  These will continue to improve leverage metrics in the next two quarters.  However what is beyond FY21?

Firstly, assuming a return to pre-Covid sales per store, there will be an unwind of the Working Capital gains made by the Company in Q1.  Additionally, with further payments of £55m due to Brait over the next two years, excess cash will be reduced.  

Another unseen risk is the increase in lease/rental payments, as shown in the Annual Report.   Historically, the Company split these payments between Plant & Equipment and Buildings, but in the Annual Report FY20, has only given the aggregated number.  The combined number has increased by 9% (£10m) versus 4% increase in number of stores.  We are waiting a reply from the Company but some of the increase will relate to the ending of the rent free period on the former 19 Poundland stores.  This increase in costs plus wage inflation are primary drivers of reducing Gross Profit margins in normal times, but are masked by the Covid-19 increase demand currently.

Iceland also remains influenced by decisions of larger supermarket chains, and their pricing decisions.  In the medium term, a return to promotional activity is likely to occure in the supermarket sector.  During the initial phase of lockdown, food supply was key, and there was no need to compete with competitors on price.  However, Tesco and Morrisons, in particular, see the crisis as an opportunity to maintain and gain market share.  This risk is mitigated for Iceland given their current market share c.2%, but gross profit margin decline is a real possibility.

The bonds will continue to trade tighter as leverage declines from current levels of 4.5x (including Brait payments) to 4.0x at year end, March 2021, but if Covid-19 passes, leverage will creep back up to 5.0x as current quarter’s EBITDA is rolled off LTM metrics.   

We remain on the sidelines, and await another quarter of results before taking any position.

Happy to discuss.

Tomas