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Summary analysis -- Missouri TopCo Ltd. --------------------------- 14-Nov-2012
CREDIT RATING: B/Negative/-- Country: United Kingdom
Primary SIC: Miscellaneous
Credit Rating History:
Local currency Foreign currency
01-Nov-2011 B/-- B/--
18-Mar-2010 B+/-- B+/--
The ratings on U.K. based clothing retailer Missouri Topco Ltd. (Matalan) reflect Standard & Poor's Ratings Services' view of its well-established market position in the highly competitive value segment and high leverage.
We assess Matalan's business risk profile as "weak." Our assessment takes into account its exposure to volatile cotton prices, slow-reacting supply chain, limited diversification outside the U.K., and a competitive landscape where Matalan competes primarily with significantly larger players in the value clothing segment such as Clothing at Tesco, part of Tesco PLC (A-/Negative/A-2), George clothing sold at ASDA (part of Wal-Mart Stores Inc. ; AA/Stable/A-1+), and Primark, part of Associated British Foods (not rated).
These constraints are in our view partially mitigated by the size of Matalan's established out-of-town store portfolio, relatively low fashion content in Matalan's clothing range; limited seasonal fluctuations; and Matalan's ability to source the majority of its goods directly from manufacturers, which enables the company to maintain comparatively low selling prices.
The ratings also reflect our assessment of Matalan's financial risk profile as "highly leveraged." Following a substantial (41%) year-on-year drop in earnings in financial 2012 (ending Feb. 25, 2012), Standard & Poor's-adjusted debt to EBITDA is currently about 8.0x. (Adjusted leverage was 5.6x as of Feb. 26, 2011). The high leverage also stems from Matalan's use of debt as the main source of financing shareholder returns in 2010. Mitigating the high leverage is Matalan's liquidity position, which we assess as "adequate" under our criteria. The company maintains this position through a non-amortizing corporate bond financing structure, strong cash balances, and positive free operating cash flow (FOCF).
S & P base-case operating scenario
In our base-case scenario, we expect Matalan's operating performance will stabilize after a period of declining earnings from higher cotton prices and we foresee that this improving trend will continue through 2013. Despite the ongoing tough macroeconomic environment for U.K. retailers we believe that top-line sales are likely to grow in the low single digit range. We forecast sales of GBP1.15 billion and reported EBITDA of about GBP100 million for financial 2013, although this hinges on the important third quarter (September-November) and December trading in the lead up to Christmas and achieving the expected gross margin improvement. The GBP100 million reported EBITDA forecast equates to a Standard & Poor's-adjusted EBITDA margin of about 14%, well below the five-year historical average of around 19%. We expect operating margins will continue to improve but consider it unlikely they will reach the historical average any time soon due to price competition and ongoing soft commodity and wage inflation for suppliers, which increase input costs.
We anticipate a gradual recovery in the U.K. economy through 2013, although this will not result in a significant improvement in trading conditions. Matalan is increasing investment in its multi-channel capability, which should support sales growth, but we expect there will be very few large-format store openings as management has revised its growth strategy. For financial 2014 we forecast sales of about GBP1.2 billion and reported EBITDA of about GBP115 million.
S & P base-case cash flow and capital-structure scenario
For the 2013 financial year we anticipate positive free operating cash flow (FOCF) of about GBP20 million. Capex in financial 2013 is likely to be about GBP25 million, rising to GBP40 million in financial 2014 as Matalan increases investment in online systems infrastructure and a new warehouse to improve its supply chain. As a result we expect FOCF will fall to about GBP10 million in financial 2014. Matalan is also looking to trial smaller format stores as part of its multi-channel strategy and making use of its cash-on-hand balances to invest in growth.
Matalan's highly leveraged capital structure is unlikely to improve significantly in the near term, with adjusted debt to EBITDA remaining above 7.5x and adjusted EBITDA interest coverage at about 1.5x for financial 2013. We foresee some improvement in credit metrics throughout 2013, provided that Matalan achieves EBITDA growth--driven by lower input costs--and if management can execute its revised multi-channel business plan. We forecast EBITDA interest cover of more than 1.5x and adjusted leverage of about 7.0x for financial 2014. The company's financing structure is non-amortizing and comprises GBP250 million in senior secured notes due 2016, and GBP225 million in senior unsecured notes due 2017.
We assess Matalan's liquidity as "adequate" under our criteria, and we believe that the company will be able to comfortably cover its needs in the near term. Our liquidity assessment is supported by our forecast that the company's sources of liquidity, including FOCF and cash-on-hand will exceed its uses by at least 1.2x over the next 12 months.
Our liquidity assessment is supported by the following forecasts and assumptions:
-- GBP117.9 million of cash and cash equivalents as of Aug. 25, 2012.
-- Forecast FOCF of about GBP20 million in financial 2013.
-- Relatively low liquidity needs other than capex of about GBP40 million.
-- About GBP17 million available on its GBP30 million revolving credit facility (RCF) as of Aug. 25, 2012.
-- Headroom under RCF financial covenants that could withstand a drop in EBITDA of more than 15% based on our forecasts.
The issue rating on the GBP250 million senior secured notes due 2016 issued by Matalan Finance Ltd. is 'BB-', two notches above the corporate credit rating on Missouri TopCo. The recovery rating on these notes is '1', indicating our expectation of very high (90%-100%) recovery in the event of a payment default.
The issue rating on the GBP225 million senior unsecured notes due 2017, also issued by Matalan Finance, is 'CCC+', two notches below the corporate credit rating on Missouri TopCo. The recovery rating on the unsecured notes is '6', indicating our expectation of negligible (0%-10%) recovery in the event of a payment default.
The recovery rating on the senior secured notes reflects our view that Matalan would be reorganized as a going concern in the event of a default. Potential recovery on these notes is further supported by our view of the security and guarantee package, which we consider to be relatively comprehensive, and by the relatively favorable insolvency regime in the U.K. On the other hand, the recovery rating on the senior unsecured notes is limited in our view by the amount of prior-ranking debt outstanding at the time of default, including the GBP30 million super senior RCF and the secured notes.
Under our hypothetical default scenario, we envisage, among other things, an intensifying competition leading to material pressure on pricing and a significant increase in the costs of goods sold as a result of raw material price inflation, rising freight costs, and currency depreciation, combined with an inability to pass these cost increases on to customers. We assume that this scenario would lead to a payment default in 2014.
We estimate that the stressed enterprise value of the company at the point of default would be about GBP320 million, in line with our previous analysis. As part of our review of the recovery analysis, we have however revised our valuation metrics to smooth out the cyclicality of earnings in our recovery analysis. Therefore, we forecast that the EBITDA at the point of default would be approximately GBP57 million (which is higher than our previous estimate of GBP49 million). This EBITDA level corresponds to our estimate of the minimum fixed charges of the company, including cash interest expenses and minimum capital expenditures spending required to run the business. We have also lowered the stressed multiple used for our valuation at the point of default to 5.5x from 6.5x, which in our view better reflects the company's business risk profile and is more in line with the multiple we used for comparable companies.
Given the intensely competitive nature of the U.K. clothing retail segment and the closure of a number of high-profile retailers during the recent recession, we consider that liquidation could also be a possible post-default outcome. While this is not our base-case recovery scenario for Matalan, we believe that the recovery prospects for both senior secured and unsecured debt could be materially lower under liquidation than under a going-concern sale, given Matalan's limited tangible asset base.
The negative outlook reflects our view that Matalan's credit metrics are unlikely to improve significantly over the near term. Although we anticipate operating performance will continue to stabilize with moderate growth in sales and earnings through 2013, downside risk remains due to the challenging operating environment for U.K. retailers and reliance on Christmas trading.
We could lower the rating if operating performance does not improve and we do not see growth in EBITDA and reduced adjusted leverage. Our ratio guidelines for a downgrade are adjusted debt to EBITDA of more than 7.5x or adjusted interest cover less than 1.5x. This could primarily result from a further weakening in the U.K. economy causing lower consumer confidence, increased discounting in response to strong competition, or adverse weather affecting seasonal sales.
We could revise the outlook to stable if margins and earnings improve as a result of low-single-digit revenue growth and lower input costs. A revision of the outlook to stable depends on Matalan maintaining adjusted EBITDA interest coverage of more than 1.5x and adjusted debt to EBITDA less than 7.5x.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Methodology & Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
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