Matalan - Calculating Supply Chain and Inflation Impact
All,
Please refer to our updated analysis of Matalan here.
After management spend most of the Q2 call managing expectations for Q3 and Q4 in light of logistics and inflation, we have put together a framework for calculating the impact of its supply chain troubles and have given inflation pressures some thought as well.
Supply Chain delays and costs:
- Q3 is seeing on average 4 weeks delay to deliveries, such that the impact is visible in stores. This should lead to low volumes / high full-price sales in Q321.
- Q4 should be characterised by efforts to clear the by then vast stock overhang from peak intake coming in during November. So we expect high volumes at low margins.
- While volumes and margins will be offsetting each other to some extent, Matalan won’t be able to hit equilibrium as intended and we are expecting a drag on performance. See calculation framework on Page 2.
Inflation:
- Matalan is seeing cost pressures both in its raw materials (cotton and viscose) as well as labour (its largest SG&A block). Moreover, logistics will add an additional charge over the coming 6 months as the company is forced to maintain extra personnel and outside services to cope with the irregular arrival of its stock and freight rates for next year are likely to rise substantially as the company’s current deal runs out in February.
- We note that these cost items are the same for the entire sector and that Matalan as a relatively long lead-time player should have more time to adjust than its peers. The company may even (theoretically) have a relative advantage in the market as many other players are forced to raise their prices before Matalan do. We have observed such effects before at Matalan as well as at other discounters, notably Takko.
Refinancing:
- As well as the supply chain disruptions have been flagged across the globe and as universal as inflation is likely to be (also Matalan Sales Prices) we continue to see Matalan as a solid investment at this time and at these prices.
- We are projecting EBITDA of £75m for FY22 (through Feb), where all the incremental EBITDA will be coming in Q3 and we have Q4 flat.
- Despite considerable WC outflows (also for rent arrears), we see Matalan with a significant cash balance and with approx. 5.5x leverage through the PIK 2LNs next year. In our opinion this should be refinance able then. If not, we think that neither the family, nor the 2LNs would be well advised to seek any restructuring and should find an agreement that allows for time.
- Should it be difficult to refinance the current SSNs, one option that could be attractive in our view would be to reduce its size in favour of a larger 2LN - to be issued at an OID that reflects trading prices then. We would be keen to discuss such an option with anyone, but as stated above, assume that refinancing will happen even without this option.
Positioning:
We are long 4% and 5% of NAV the 2LNs and the SSNs respectively. Discount retailers are under no immediate threat of replacement by any other channel (online) and so will return to serving the very same market segment they have addressed before the pandemic. Cost pressures will be passed through. All else is transitory in our oppinion and should the occasion arise to hold Matalan equity at £400m, we’d experience some unwelcome wobbles (presumably one could buy in lower than now) but we’d ultimately be happy holders.
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk