Nov 2, 2016
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Debt squeeze shows pressure on UK retailers

Nov 2, 2016

Heavy discounts on debt issued by some big UK retailers reflect growing commercial pressure after Britain's vote to leave the European Union and ahead of the crucial Christmas trading period.

Bonds issued by department store House of Fraser last week joined unlisted fashion retailers New Look and Matalan in trading below 90 pence in the pound, indicating that bond investors are braced for potential losses on the debt.

The value of House of Fraser bonds fell to 83 pence from 90 pence, raising questions about the health of the chain bought in 2014 by Chinese conglomerate Sanpower even as it prepares to open its first store in Nanjing in China.

"This House of Fraser issue and news of heavy machinery renter Hewden coming under pressure could raise concerns of a post-Brexit impact on UK corporates," said Anthony Lawler, head of portfolio management at hedge fund investor GAM.

"Whether this is a one-off or a canary-in-the-coalmine is way too early to tell," he said.

Hedge funds often buy distressed debt as a bet they can make returns on a rise in bond prices if the company is turned around, although investment in a firm's bonds could also signal an interest in taking control.

Britain's economy has performed better than most forecasts since the June Brexit referendum, largely thanks to strong consumer spending. But surveys show consumers are becoming more pessimistic as sterling's slump cuts disposable income.


Fashion chains are seen as more exposed than other retailers because they could struggle to pass on cost increases from the pound's fall as the market has become reliant on discounts to clear stock after periods of unseasonable weather.

"It might be difficult for clothing retailers to make price rises stick especially if discretionary income is under pressure from inflation in other less discretionary spending like food," said David Beadle, a senior credit officer at ratings agency Moody's.

Britain's Next reported sales on items without markdowns in its third quarter fell 3.5 percent and warned that the weak pound could increase the cost price of garments by up to 5 percent in 2017 in a worst case scenario.

House of Fraser reported sales for the eight weeks to Sept. 24 fell by 2 percent but said it was cautiously optimistic for the rest of its fiscal year, with the Black Friday and Christmas period usually accounting for about 85 percent of annual profit.

"The Christmas trading period is clearly critical for them," said Sohail Malik, co-founder and portfolio manager at Roxbury Asset Management. "As for the major shareholder and future support, questions remain."

Owner Sanpower did not respond to a request for comment and House of Fraser declined to comment.

Founded in 1849, House of Fraser operates 62 stores in the United Kingdom, Ireland and the Middle East. It is opening concessions of British toy retailer Hamleys, the chain which Sanpower bought last year, and has appointed two new senior managers to help review its strategy.

Moody's has warned it could cut its outlooks for House of Fraser (which it rates B3 stable) and New Look (rated B2 stable) if they do not take actions such as cutting capital expenditure or costs to preserve liquidity.

However, Moody's Beadle said the concerns were not immediately pressing: "Neither House of Fraser nor New Look have imminent debt maturity to worry about."


New Look refinanced its debt last year following its acquisition by South African tycoon Christo Wiese's investment vehicle Brait SE, extending its average debt maturity by four years and cutting average interest costs to 6.3 percent from 9.4 percent.

It has 877 million pounds in debt that matures in 2022 and 2023, trading at 89.5 pence for secured notes and 79.5 pence for unsecured.

House of Fraser also refinanced its debt last year, issuing a 175 million pound floating rate note that matures in 2020 as well as a 125 million loan and a 100 million revolving credit facility.

Family-owned Matalan, which runs 226 stores in the United Kingdom, is under more pressure.

In April, Matalan said it had amended conditions for a 50 million pound revolving credit facility with Lloyds after it was placed in the bank's support unit for troubled companies.

Matalan reported earnings before interest, taxation, depreciation and amortisation (EBITDA) almost halved to 56.2 million pounds ($69.2 million) for the year to Feb. 27 due to warehouse problems, but it has reported a recovery since then.

However, outstanding debts of 492 million pounds that mature in 2019 and 2020 are still trading at heavy discounts: 75.9 pence for the secured tranche and 65.5 pence for unsecured debt.

"We expect they will need to actively consider refinancing options during the course of next year," said Beadle.

Matalan declined to comment.

Major listed retailers such as Next and Marks and Spencer have also seen the price of their debt fall steadily in the last year, but Moody's says both can cope with lower profitability and higher costs.

Moody's rates Next Baa2 stable and M&S at Baa3 stable, predicting Next's profitability will be more resilient as its expected sales decline is less pronounced.

"Both M&S and Next have a decent amount of headroom in their rating categories although they face the same challenges as the rest of the sector," said Beadle.

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