9th November 2018

We outline recent credit developments at Distribuidora Internacional de Alimentación (“Dia”) and Tesco as well as the impact of the ECB on bond pricing.

DIA is predominantly an Iberian supermarket, whose stocks and bonds have experienced something of a roller-coaster ride since October. Unfortunately for DIA and its key stakeholders, the ride is unlikely to be over anytime soon.

Sources: , Bloomberg, JPM, Creditsights, Company Accounts and statements, revenue and profits converted at 1.3 for Tesco (GBP) and 1.14 for Dia (Euros)

The supermarkets share other similarities; i.e. large store network and emerging markets exposure. They both face intense competition from both discounters and online competitors.

A key difference, is their respective trajectories for leverage; Tesco has been paying down debt, whereas Dia appears to have seen a material increase in its leverage.

Dia’s rise in leverage appears to be due to an increase in short term debt and a drop off in EBTIDA. Reasons for the fall in EBITDA appear to be driven mainly by margin pressure from intense competition and currency depreciation in emerging markets. Ratings agencies (Moody’s and S&P) subsequently downgraded Dia to HY, thereby increasing the funding costs ahead of any potential refinancing.

Meanwhile, Tesco got upgraded to investment grade in October, after a huge effort by CEO Dave Lewis and his team to to boost cashflow, profits and reduce debt levels following its downgrade to HY in 2014.

DIA have 3 bonds outstanding including one with a coupon of 0.875% for 2023 maturity.

Source: Bloomberg, as at 8 November 2018

Tesco has a handful of bonds denominated in Euros, including one that was issued in October following the upgrade (TSCOLN 1.375% 23), which is currently trading around its re-offer price.

It is clear that both credits are susceptible to a range of risks, for example with DIA, risks include:-

• Highly competitive industry
• Dia is not the market leader (whereas Tesco is easily the number 1-2 Supermarket in the UK by market share)
• Mid cap enterprise value (Dia had a c. €3bn market cap when it raised its 2023 bond in 2017)
• Risks of operating in peripheral Europe
• Exposure to emerging market risks

The point about mid cap vs large cap is important, as large caps tend to have more levers they could pull to get themselves out of trouble. For example, Tesco had multiple lines of access to finance, i.e:

• Unsecured Bonds in multiple currencies
• Property Bonds (Tesco Property Finance)
• Bank loans and credit facilities
• Commercial paper
• Leases
• Large, diverse, shareholder base for raising equity – which they did not need to do

In a pre-QE era, it would have been abundantly clear that a 0.875% coupon would not be enough compensation for a 5 year bond from Dia. However, the direct intervention by the ECB in the European Corporate Bond market has facilitated this type of tight pricing. It is not the first time that an ECB owned bond has experienced extreme volatility, last year, Steinhoff’s Euro denominated bonds experienced wild swings after accounting irregularities were discovered in its business. The difference between Dia and Steinhoff is important, Dia has experienced more of a traditional risk, that could affect many businesses as they go through cycles, whereas Steinhoff was down to specific actions by individuals that could be considered more idiosyncratic. Therefore as time goes on, there is rising probability that we see more companies that could experience problems as a part of the natural business cycle.

With the ECB tapering its purchases in October, and eventually stopping the purchases of new bonds (except re-investment) in December, it is highly unlikely that Dia (or a similar credit) would be able to lock in the sort of low coupon it achieved on its last public bonds. From an investor perspective, those who followed the ECB during the early stages of the bond buying program must now be able to weather the impact as the Central Bank steps back from the primary market in Europe.

For more information please contact Rubrics Asset Management. info@rubricsam.com.

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