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UK’s Best Kept Secret

27 January 2017 by Pierre Beniguel

With less than two months to go before Theresa May is expected to trigger Article 50 – assuming the bill passes through Parliament – the primary market for sterling high yield bonds remains as healthy as ever, as investors continue to scramble for yield. In the year to date there have been four notable debut issuers: Amigo, a guarantor loan company, who issued £275 million; New Day, a credit card issuer for those consumers with poor credit history, also issued £275m; TalkTalk, the mobile & broadband provider, issued £400m; and then earlier this week, B&M announced it was road-showing investors for a debut bond.

B&M is case study worth highlighting: the UK discounter has a relatively extensive high street presence with more than 530 stores across the UK. It focuses on a relatively small number of items but at a highly competitive price compared to its peers, with around 75 % of B&M products retailing at under £5. Having launched its IPO in 2014 B&M has become a reasonably sized company with gross revenues of £2.2bn and a market cap of £3 billion. The company has decent credit-metrics with leverage of around 2.25x and fairly stable margins of circa.10%, which have resulted in a Ba3/BB- rating by Moody’s & Standards & Poor’s respectively.

So what’s not to like about this new issue then?

Equity investors are focused on the upside and understandably they find B&M an attractive stock. And according to Bloomberg, more than 80% of the analysts covering B&M have an equity buy recommendation. Over the last two years, the discount retailer has been able to grow its top line by an average rate of 26.6% and it intends to keep on growing at an elevated rate over the next few years. It gets even better; as it grows B&M is able to protect its gross margin or EBITDA margin. Why did we pass on a deal where the equity coverage is about 13 times the EBITDA? We felt the equity and debt returns were asymmetric. While the equity investors would enjoy all the benefits of the high growth B&M is able to achieve, debt investor will be left with a bond which was issued with a coupon of 4.125%. When growth is high, risks are high. We do not believe investors should be blind to the UK competitive retail environment or the implementation risks associated with a high growth strategy. The pricing of the bonds did not feel adequate or reflect the potential risks.

B&M debut bond is trading well this morning and was up 2 points. As for the other sterling high yield new issues, trading has been driven by technicals specific to each bond. TalkTalk initially rallied but is currently down about 2 points; Amigo is up about 2 points and New Day is down about 1 point. At TwentyFour we follow the sterling high yield market closely but decided not to participate in any of these transactions for fundamental and relative value reasons and not be lured in by short-term technical strength.

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