Matalan - For all the right reasons

All,

Please find our updated analysis here.

Vindication has been a long time coming. Reading through our religiously bullish notes on Matalan over the last two years, we must admit that several times along the way we thought we’d be well out of the crisis by now. But the pandemic is still with us and so - behold - is Matalan, rocking a £100m EBITDA (on first impressions only). Our 2LNS are on fire.

Importantly though, Matalan is pulling through this crisis remarkably well and for all the right reasons.

Why the strength:

- Anti cyclical behaviour: Like many discounters, “stuffy" Matalan is exactly the address the Great British housewife returns to in times of uncertainty. We’ve written endlessly about this cliché, so we won’t bother you anymore with it.

- Well invested estate: Matalan go through their store refurbishments in waves. The latest wave only completed just prior to the pandemic, so stores look fresh and attractive.

- Large surface: The out of town/retail park location suits customers looking to travel and shop in relative isolation.

- Travel restrictions: Consumers unable to spend their money in or on flights to Ibiza have had more time and money to spend on retail therapy than previously.

Inflation:

- Drivers for inflation include raw materials (cotton), shipping, logistics, but importantly also wages and savings. The latter two factors offset some of the former and make for a generally conducive environment to hike prices.

- Matalan have relatively long lead times when it comes to volume commitments and in an inflationary environment are therefore more able than others to sit in the back of the buss and capture market share while others have to push prices.

- It’ll be ugly anyway. We assume it will eat all margin investments Matalan have recently made, although it may not have to be so.

Refinancing:

- Matalan has learned to live with the commotion in its supply chain and on its newfound footing looks able to sustain at least a £90m EBITDA. Note that we subtract an amount from its indicated £98-100m EBITDA due to a proportion of its Q2 EBITDA stemming from the sale of discounted AW stock from the prior financial year.

- On the reduced EBITDA however, we still see Matalan as only 3.5x leveraged through the 2LNs, even after repayment of deferred rent and a high level of trade payables, which is a result of the late arrival of stock.

- Whether or not Matalan can refinance may be beyond the pallet of many investors, who should be looking to the rating agencies for opinion. Those might however take long to convince, which could complicate the refinancing more than it should.

Positioning:

- We remain long the SSNs and the 2LNs for what has become 4% and 6% of NAV. In our more long-term view, we consider Matalan at £350m a steal - should it ever come to that. Before the company falls over a £90m stub piece, there should be a raft of investors and opportunities - including Far Eastern clients, invested with long payables, who would happily partner with Hargreaves before he enters a court battle over his stake in the company.

- Further to previous comments, the dreaded scheme or plan scheme scenario feels mute. To make this scenario interesting to Mr. Hargreaves, he would have to bring fresh cash and pay tremendous fees. In that case, he could just buy out the 2LNs and save himself the trouble.

- Just why those 2LNs are still not at par is beyond us. There are other names out there that trade much tighter with substantially more default risk.

Please reach out to discuss,

Wolfgang

Wolfgang FelixMATALAN