ASDA - What to make of those sales and margins

All,

Please find our slightly updated analysis here.

ASDA’s Q2 top line was weak, partially due to distribution issues hurting store availability. Gross margin continues to improve as ASDA captures some lower costs at higher prices. EBITDA margins are rising as marketing costs (price support) reduce. ASDA is still losing market share, and pressure on margins could return. The industry environment is only easing very slowly.

 

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 91.75 p/£. 

- 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 recent results showed profitability is improving, supporting our thesis for the company.

- Our valuation of the company has not changed with the Q2 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 

- Asda is cash-generative, and once the IT CapEx 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. 

- The maturity wall in 2026 has been dealt with. The Apollo loan and the €TLB represent a GBP1.4bn maturity wall, but we do not see this as impossible.

- ASDA has a maturity wall in 2026, but by September 25 EBITDA and cash flow should have improved significantly as volumes and margins return with inflationary and cost-of-living headwinds reducing. 

 

Recent trading has been tough, but there are green shoots:

- 24Q2 non-fuel was down 5.3% LFL, management has said the underlying performance was down 2.6% (better but still bad). Part of the problem was product availability, which has been blamed on logistics potholes created by introducing new IT systems. These issues have been resolved according to management, but we think revenue growth will be constrained for the rest of this year.

- EBITDA margins were up 80bps sequentially (IFRS16 adjusted), and Gross margins were up 12bps to 14%. The 140bp gross margin expansion vs 23Q2 does demonstrate that ASDA is retaining some of the inflation in costs. Keeping marketing costs (price subsidies) lower in H2 will be difficult if ASDA continues to bleed market share. We have assumed margins will fall slightly in the second half. 

- The lower top line flowed through to a negative move in working capital, but days in inventory were in line with our expectations, so we are not worried. The undrawn RCF (£793m) and cash of £531m are more than adequate. - ASDA has cut back on expansionary capex on the convenience business. The new guidance of £350m - £370m was marginally above our forecast. ASDA is cutting back the pace of the convenience format rollout. We have been sceptical that the new format will not cannibalise business in the large store format for all participants. The market will not grow, but we get the attractiveness of the higher margins. 

 

I look forward to discussing this with you all

 

Aengus

E: amcmahon@sarria.co.uk

T: +44 203 744 7055

www.sarria.co.uk

Aengus McMahonASDA