Market Wrap

Friday Workout - Commodities running out of gas; Beds, Sheds and Floors; Utilising RP capacity

Chris Haffenden's avatar
  1. Chris Haffenden
17 min read

Just when we thought the latest European High Yield rally had run out of gas — for some issuers almost literally — yet more M&A activity lifted one of our watchlist names out of distress as Atalian matched Aston Martin’s 20-point plus gain from the week before. Yet another positive event for a borrower that seemed set for a restructuring, their Q2 and H1 results released hours later were poor. Carlyle Global Credit says it has led the private credit financing for the combined facilities management group (with OCS) brought together by CD&R, worth over €2.5bn.

With LevFin accounts dreaming of the beach after a difficult H1, the latest M&A for jumbo deals such as Atalian and Masmovil/Orange is to be funded by private credit and banks. Some banks are deciding to use their balance sheets again, flipping their bridges to amortising term loan A’s (a relic of the naughties when Lev Loans were a bank market) rather than sell at deep discounts.

Are we going back to the future in Leveraged credit?

The surge in gas prices after yet another cut in Russian output may have masked significant reversals in many bulk commodities in recent weeks which might finally provide some relief to some of our borrowers whose margins have increasingly come under pressure in Q2. Mind you, that is if you can secure the supply and not run up inventories, and/or hedge at the top.

For example, the agreement over Ukraine grain exports may finally provide some relief for our shopping basket of French bakery and biscuit loan deals, whose loan prices and earnings have been crumbling all year. Wheat prices are back to price levels seen before the war started.

Source: Trading Economics

Elsewhere, Auto manufacturers have big customer order backlogs but have struggled to fill orders due to chip shortages. This has had a knock-on effect for their suppliers.

But when the chips (prices) are down:

This may provide some relief to Jaguar Land Rover after another torrid quarter, with the car manufacturer still one of the worst affected by chip shortages. JLR is struggling to finish old model builds with a slower ramp-up of new models, most notably the Range Rover Sport.

Working capital outflows led to a £770m cash burn which caused their long-dated bonds to understeer badly, falling by more than four points. But with ample liquidity, short-dated paper looks the best drive for a recovery, its Jan 2024 bonds have showroom appeal at 92.75-mid to yield 7.5%.

Jaguar wants to keep a substantial cash buffer, and avoid going to bond markets, given how unattractive pricing is. It is worth noting, however, some bank facilities required a minimum £1bn cash balance. It had £3.7bn of cash as at end-June, with another £1.5bn available under its RCF, which it says it intends to push out the maturity.

Management said they were seeing light at the end of tunnel on chip shortages, agreeing a long-term supply agreement mid-quarter. Cost inflation was £161m, mostly due to aluminium prices. But these were reversing, ending up lower at quarter end with expectations that commodity prices would come down going forward.

Falling aluminium prices might provide some relief for Forgital — the Italian manufacturer of forged and machined components for the aerospace industry — who entered our distressed universe in July. Downgraded by both ratings agencies to triple-hook as leverage hit double-digits, the business is incredibly energy intensive and EBITDA margins compressed by 700 bps in Q1.

If that wasn’t bad enough it is mostly supplying to the wrong aircraft segment — do you know of anyone who wants a wide body?

As second quarter earnings reporting season gets underway, the impact on EBITDA margins from sharp rises in input and energy costs for many EHY companies is now plain to see. The screenshot below is from our earnings flash of yesterday morning:

One of my favourite shorts Ontex posted its H1’s this morning. It said “unprecedented cost inflation continuing to negatively impact EBITDA (-53% YoY) despite savings, volume growth and pricing ramp-up.” Adjusted EBITDA margins fell 7.2pp to a mere 1%. The sale of its Mexican division may provide some encouragement for its bondholders, but is AIP still bidding — there was no mention of the status of the talks in the release and the CEO shut down investors questions in the earnings call.

But while the first wave of the bear market was a correction of markets and assets inflated by excess liquidity, geopolitical concerns, and supply shocks, which may now be finally abating, could there be a second wave from weaker earnings and economic stresses?

Is price risk about to turn into volume risk?

Beds, Sheds and Floors

This week at 9fin Towers a lot of our discussions were about Beds, Sheds and Floors, a Court Room with a Vue, and a lack of appetite for Foie Gras.

Stand by your beds

Swedish bedding and mattress producer Hilding Anders still hopes to secure unanimous lender consent and avoid using an English Scheme of Arrangement to implement is restructuring. As 9fin’s Lara Gibson writes, they still needed two lenders holding around 15% of the debt to agree by yesterday’s extended deadline. It is unclear whether this will be extended further.

Under the plan, €562m of outstanding debt will be bifurcated. €300m of senior debt will be reinstated into a new facility maturing in February 2026. The remaining €260m will be exchanged into a HoldCo PIK paying 12%. Sponsor KKR will gradually sell the different business units and this debt extension will allow them time to complete the disposals, as reported.

A timeline for the sale of the Russian business has not been set as it’s difficult to predict what will happen with the war in Ukraine. Askona, their Russian JV, generated 52% of group EBITDA in the year to November 2021. Russia made up 38% of net sales and 53% of its employees were in the country. Under the proposed terms, Russian subsidiary Askona will be taken out of the restricted group and covenants will be tightened.

“What can we do?” said one buysider to 9fin this week. “We’re not particularly happy with the deal, but we understand it’s not the company itself that is creating the situation. Russia used to be the best part of the business and now, this restructuring is the cost of the invasion. There's just no good opportunity to get money out of the business.”

50 sheds of grey earnings

Keter continues to shed EBITDA, dropping 9.6% YoY YTD to May 2022 and 11.4% lower than budget. As 9fn’s Laura Thompson writes this is despite a 20.2% YoY recovery in net sales and a 1.7% boost from budget, indicating that the BC-Partners manufacturer of resin-based consumer goods (plastic sheds in plain English) is struggling to manage rising costs, with cost of goods sold up 27.1% YoY on a 33.2% logistics uptick. Management wrote in its earnings update it is “actively implementing” price increases and cost takeout actions, to bear fruit in H2 2022.

Leverage rose by half a turn from 4.2x in May 2021 to 4.7x in May 2022, albeit -0.2x below budget. Gross profits, rose 7.5% YoY. As of YTD May 2022, it had €52.3m cash on hand (plus €110m RCF undrawn), roughly on par with last year’s €55.1m, while FCF fell to -€85.4m.

Unable to escape to the bottom of the garden, Keter must refinance around €1bn of debt maturing in November 2023. This will be tough to pull off, after a failed January refi, as investors fretted about a historical issues amid concerns over its key input, oil-based resin, and subsequent worries about post Covid consumer discretionary spending as we head into recession.

It’s loans are in the mid-80s, no Sheds Heaven for sponsor Carlyle.

Victoria ah nah

Sometimes we are floored by price movements post earnings releases.

Once such example is Victoria Plc whose bonds rose five-points after releasing its FY 22 earnings last week. 9fin’s Denitsa Stoyanova couldn’t see much to be positive about, and after a couple of days of deeper analysis, picked holes in the UK-based flooring firm’s numbers.

Some highlights (or should that be lowlights):

“Victoria reports a high teens underlying EBITDA margin (18% on average for the last five years) but this has been plumped up by what management calls “non-underlying items”, which are mainly costs related to acquisitions and redundancies after M&A. Since the group’s strategy is to be in a continuous acquisitive state, we consider these costs business as usual.”

Margins therefore are 2 ppt lower at 13.8% compared to 16% as reported by management.

“Demand is not as inelastic as management suggests — despite raising prices four times in FY 22 (financial year end 2 April 2022), Victoria has struggled to fully pass-through significant cost inflation… In effect management took the decision to sacrifice some profit margin in FY 22 to protect volumes.

“Acquisitions are typically earnings dilutive, or at least until they are fully integrated with the average multiple paid in FY 22 at 5.7x. Leverage is optically low at 2.7x, but we would include £225m in preferred equity to Koch Equity Development which management says it intends to redeem in cash. If we include the prefs and use reported underlying EBITDA it rises to 4.7x, and if we use 9fin adjusted EBITDA this rises further to 5.4x.

Management thinks it commands a higher multiple of 10x given its larger scale and diversification, but another 4-5x on top? Surely, the multiple floor is much lower.

As Denitsa says: “if we apply 5.7x multiple to our 9fin adj EBITDA estimate, it gives a valuation of £798m for the business, which fully covers the senior secured debt. This is slightly lower but broadly consistent with its trading valuation of £872m (based on £465m market capitalisation as of 26 July 2022 and £406.6m net senior debt). However, keep in mind that the group can repay its prefs (plus any unpaid dividends) in cash at any time (see p122/2026s OM) before the maturity of its debt, which may result in at least £254m of value leakage. This would leave only £544m of value which is equivalent to 70% coverage for the senior secured debt. If you believe that the business generated £162.8m underlying EBITDA (per management calculations), the senior secured debt coverage rises to 85% respectively.”

The bonds appear fairly priced on this basis. But I would be checking the docs. Given the depressed levels at which its equity is trading, management said they are actively considering share buybacks this year as well, so this may be another potential cash drain in FY 23.

Tarkett Practices

French peer Tarkett has splintered investors. As Kat Hildago writes, the designer of manufacturer of durable flooring is suffering from high raw material costs (most notably PVC) and significant exposure to Russia. The company’s €950m TLB dropped into the 70s but are now indicated at 84.25-mid, rallying over five-points since the earnings release.

Tarkett stopped significant investments in the region following the invasion and, as the company reported in its Q1 2022 earnings, it expected “a fall in demand and increase in supply restrictions,” leading to a “marked slowdown” in the second quarter.

However, some buysiders remain reassured by its solid market position, strong liquidity, and a well-performing sports surfaces business.

Tarkett’s adjusted EBITDA margin from 8.2% in FY 21, to 7.8% for LTM to June 2022. Its cash position fell from €205.4m at end-FY 21, to €140.3m at the end of June 2022, driven largely by working capital consumption: Inventory was the main culprit rising from €471.7m to a whopping €724.7m in the same period.

Leverage is low at 3.2x — below the 3.5x opening leverage last summer — but a turn above FY21.

The company’s earnings release said that “the high level of inflation affecting raw materials and on-going supply difficulties have changed the structure of the working capital requirement, leading to a significant increase in the inventory value and a shorter supplier payment period.”

Tarkett said they typically stockpile before their busiest period, H2, as historically this is the period when working capital unwinds and the cash position improves. It drew down €180m from its €350m RCF in Q1 22, to plug a €240m cash burn in the first half. With such a dramatic cash outflow, we will be closely watching their third quarter numbers very closely.

Court Room with a Vue

Unable to secure unanimous lender consent Vue was in the High Court this week for its English Scheme of Arrangement convening hearing. 9fin’s Lara Gibson headed down to the Rolls Building on Wednesday, but she literally had to get on her bike — back to 9fin Towers — after the hearing was switched to Teams due to the train strikes.

When finally up online, the hearing was short, uncontroversial and straightforward, given over 90% of creditors (up from 82% yesterday) signed lock-up agreements. Justice Joanna Smith approved the Scheme meeting on 26 August, ahead of its sanction hearing on 5 September.

The English Scheme is constituted with just one creditor class comprising the 1st lien creditors who hold the RCF, TLB and senior secured term loan (SSTL). Justice Smith confirmed there was no class fracture. The 2nd lien holders are deemed to be out of the money and are not subject to the Scheme and will be wiped out under the restructuring agreement.

First lien creditors are estimated to receive a return of around 75% through the Scheme but would likely only receive a 48% return in the event of an accelerated sale.

Daniel Bayfield QC for the company outlined that the group urgently needs to effect the Scheme as the company faces a serious liquidity crisis forecasting a £7m shortfall in September 2022 and is unable to meet its obligations. Vue is seeking to raise £75m under a new loan facility ranking in priority to its existing debt paying E+800 bps and maturing on 30 June 2027.

The financial restructuring plan involves first lien lenders taking 100% of the equity, with the £160m second lien facility (majority owned by OMERS) wiped out and approximately £465m of existing debt (including the 2L) set to be removed from the balance sheet, as reported.

Difficult to swallow

We might have relished editing French food producer Labeyrie earnings update from Laura Thompson’s and Kat Hidalgo, but investors might have found the French food company’s results more difficult to swallow.

The PAI Partners-owned biz reported a -24.4% drop in YTD May 2022 EBITDA (IFRS 16) to €67.9m, with EBITDA excluding IFRS 16 down -25.3% to €64.7m — a 24% and 25% miss from budget respectively. LTM May 2022 adjusted EBITDA, meanwhile, was €81.6m, with adjustments including €9.9m in non-recurring items in June and May 2021 and May 2022. Consolidated senior secured net leverage for the same period was 5.4x, up from 4.5x the year prior, while total leverage at 5.7x from 4.5x — however, YoY comparisons are muddied by July 2021’s refi.

Labeyrie is another business that has been hit by France’s limitations on price negotiations with food producers. Normally, food retailers are allowed to negotiate with food producers only once per year in February — meaning many French companies locked prices in before they spiralled following the invasion of Ukraine.

The French government then allowed another tariff increase in June, but lenders were unconvinced this would be enough to keep their portfolio companies buoyant, including names such as CereliaEcotone and Biscuit International. The changes were due to come into effect in July for Labeyrie, meaning those impacts have not yet come through in the numbers.

Long-term, lenders also worry on the ESG snags on Labeyrie’s products such as foie gras, which involves the force-feeding of ducks or geese. The production of it is already illegal in the UK and could present a refinancing risk if ESG sentiment in lenders grows to the point they would snub the credit. Further regulation is also an overhanging concern.

Labeyrie priced a €455m 2026 TLM at E+425 bps and 99.5 OID in July last year, refinancing its existing capital structure and repaying €10m of PIK debt. The loan has been trading down steadily since December 2021 and is now indicated at 75-mid as of 26 July 2022.

Utilising RP capacity

Don’t worry readers, I am not about to stray into our legal team’s domain. We are not talking about Restricted Payments here, by RP, I mean the new UK Restructuring Plan.

I posted an update this week on what is next? It’s over two-years since the entry into law of the UK Corporate Insolvency and Governance Act, and the introduction of UK RPs. Automatic recognition of UK judgments in the EU disappeared 18-months ago due to Brexit, but despite widespread concerns, the bulk of foreign restructurings continue to head to the UK.

Restructuring Plans have been successfully adopted with a number of important precedents, with a number of cross-class cram downs. RPs are costly, however, and the UK insolvency service has made some suggestions to make them more accessible to SMEs.

In conjunction with the University of Wolverhampton, in June it released its interim report on the 2020 Act. According to market participants they interviewed a number of restructuring professionals on their thoughts on the UK RP, and the moratorium. 

The report says that the RP is a “fantastic initiative” and “particularly useful.” But it adds that RPs are too costly and time consuming, especially for SMEs, with fees often spiralling into seven figures. It is too costly to challenge, deterring actions from dissenting creditors, and requires greater disclosure and transparency.

Most notably, the Insolvency service has suggested widening the scope and reach of Plans, to expressly say that they have extra-territorial effect. This would reduce costs and uncertainty.

US Chapter 11 claims to have worldwide effect meaning that their moratorium can stop enforcement and legal moves in other jurisdictions. While some courts may not recognise its global reach, company, bank, and fund executives are unlikely to entertain the prospect of being in contempt of court, and potentially serve jail time, if they then decide to set foot on US soil.

There are question marks whether the UK would have the same clout, but it is the second largest financial market, so it’s worth a go, said one restructuring lawyer who was consulted on the idea.

Other suggestions are allowing more judges and courts to hear RPs, reducing the amount of documentation, and removing the convening hearing, the lawyer said. The stipulation that a company must be in ‘financial difficulty’ could also be removed.

But as DAC Beachcroft say in a client note, the way forward can lie within the legal and financial advisor community, and greater familiarity and an insistence by the courts in simpler cases to keep evidence ‘clear and concise’ with ‘robust project management’ essential.

Houst wins

There was encouraging news last week, that some of this advice is being taken on board, with last week’s sanctioning of Houst — the first SME UK Restructuring Plan. In their RP, HMRC was bound as a dissenting class despite being treated differently in priority than under the relevant alternative to the plan — a pre-pack administration. It might even be seen as the first cram-up.

The online property management company for short term holiday lets had entered into financial difficulties during Covid. It owed money to Clydesdale Bank, HMRC, trade creditors and suppliers, a connected creditor, and customers.

The plan included a £500k capital injection from certain shareholders, in return for new shares giving 95% of the enlarged equity, reducing bank, HMRC and unsecured debt. According to a Freshfields note it would lead to:

As you can see from the terms above, the bank now has the best outcome, albeit couple with a prospective better outcome for HMRC. The tax office rejected the plan on principle as unsecured creditors would have got some recoveries, despite HMRC not being paid in full.

Is this the first cram up (unlike other processes, there is no absolute priority rule in the UK)?

I agree to an extent, said a second lawyer. “HMRC ranked second to the bank as a fixed charge security holder in an administration, there was little value in Houst’s assets subject to a fixed charge security – so HMRC would have received the largest dividend in an administration.”

However, Clydesdale was the senior creditor and voted in favour so I would query whether this is “cram up” the lawyer. “Zacorroli said HMRC is a sophisticated creditor able to look after its own interests, which had full notice of the plan and had not attended hearings to oppose it. The tax authority also failed to present arguments against sanction or negotiate an alternative deal.”

Staying ahead

With restructuring activity expected to pick up in 2022 and into 2023, it is good to see that the UK is not getting complacent, despite its dominant position in the implementation of foreign restructurings. Domestically too, plans to reduce the cost of UK Restructuring Plans are timely, given a number of CBILS loans are now in their last year and many unlikely to be repaid. Greater use of the new tool is desperately needed for SMEs to restructure and avoid insolvency.

It is too early to say whether the UK joining UNCITRAL Model Law or the suggested extra territorial effects of RPs will move the dial and increase the number of deals coming to the UK.

I was asked yesterday whether we could we see companies to go to the UK rather than the US to get global effects? That might depend on whether the moratorium is improved, I would be interested in the thoughts of any restructuring lawyers reading this.

What we are reading this week

The FT’s deep read by Rob Smith and Kaye Wiggins on the Morrisons buyout was journalistic marmite for my peers. A Managing Editor at another publication called it ‘sensationalist and tabloid’, feeling so strongly he told me over a beer, that he had posted a critical comment under an alias. I agreed the FT was playing catch-up and concurred that under journalistic omertà they should have recognised a series of scoops by Bloomberg on the debt placements in 2022.

But it provides a great narrative on the situation, and will be remembered (rightly or wrongly) as the definitive editorial piece on the UK supermarket. As regular workout readers will know, I had also compared the deal to Asda, adding Morrisons is a metaphor for the 2022 LevFin bust, just as Boots was in 2007. Sometimes as financial journalists we can get too fixated by scoops, telling a good story that engages readers and reviews a long-running situation can require more skill.

To avoid getting us too bullish here Andromeda Capital Management says: “The last twenty years were a period of low inflation, few geopolitical frictions, free-trade, and neoliberal policies. We believe this stable, goldilocks environment is over. Record high inequality, persistent inflation on higher fiscal spending, rising geopolitical risks and climate polarisation will shape the future investment environment. Here’s how we think investors should get ready for this challenge.”

The rise in private credit has caught many by surprise this year. In less than a quarter it has gone from the buyer of last resort, to buyer of first resort.

As private equity players see their deals becoming more difficult as financing tightens, multiples contract and IPO exits diminish, their private credit arms are thriving. As the FT reports, Carlyle’s credit business has overtaken private equity for the first time in 35-years.

Ben Hunt at Epsilon Theory is raging against Fiat news — which he says has Fifteen Faces. He has set up a Narrative Early Warning System or NEWS “to inoculate the world against the weaponized narratives of Big Tech, Big Media and Big Politics.” Yikes

Finally, the best and most engaging video explainer I’ve seen — Bayesian probability for babies.

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