British grocer Iceland is drawing on euro as well as sterling funding to achieve its size and pricing objectives as it seeks to raise £475m-equivalent of December 2027 senior secured notes to partially redeem 2025 sterling-denominated debt.
The frozen food specialist (B3/B/B) will issue new senior secured notes as it tackles maturities in its capital structure by also tendering for £500m of its £550m 2025 senior secured notes at par.
The transaction will be only the third time a borrower has tapped sterling high-yield investors for size this year, following Travelodge on April 21 and Ford Motor Credit Company on February 27, which one banker away from the transaction attributed mostly to issuers' unwillingness to pay current market levels rather than low investor demand.
A banker with knowledge of the transaction noted that the sterling market remains "tricky" in terms of liquidity and price, as it still lags the recovery in the euro market. For that reason, UK-focused companies are also using non-sterling markets to try to balance their funding needs with their pricing objectives. At the same time, though, Iceland has a UK investor following, so issuing in sterling is also important, even if pricing terms aren't in that market's favour.
"There is still a big delta in price between euro and sterling. Clients are better off issuing in euros and swapping into sterling, which is what Iceland will do," he said, adding that the euro leg was signalling good pricing despite coming at a premium based on its credit ratings. The notes are rated B3/B/B+.
Price talk for the sterling-denominated December 2027 non-call two senior secured fixed-rate notes came at mid–high 11%, while talk for the euro December 2027 non-call one floating-rate note was set at Euribor plus 550bp and a 96–97 OID. While the size of each tranche is still to be determined and may change, the euro portion is likely to be no less than €225m, the banker said.
While existing holders were expected to make up the majority of book for the new issue, new accounts are also placing orders. The banker said the rollover ratio is good, but noted demand from new investors has exceeded expectations.
"We have a lot of demand from new guys and people who didn't own the bond. Some of the largest UK real money funds have given us very sizeable orders at a very competitive price," he said, adding that the trade was already oversubscribed.
Analysts recommended clients to participate in the new deal as they deemed IPTs as attractive compared to secondary trading levels. A banker away from the transaction calculated that the fixed-rate leg would probably offer a new issue premium of between 50bp and 75bp if it printed at an 11.25% yield, inside talk.
Working out fair value isn't straightforward. Iceland's £250m 4.375% May 2028 bond, which is next callable in February 2024, is bid at a yield of 10.34% and cash price of 77.87, according to Tradeweb. It was quoted at 9.55% at Friday's close. Iceland's CDS and Asda 2026 bonds are also being factored in.
Proceeds from the new notes, together with £35m of cash on hand, will be used to repay £500m of the existing senior secured notes due 2025, including accrued and unpaid interest as well as £10m of transaction-related fees. As part of the transaction, Iceland intends to extend its revolving credit facility to November 30 2027.
Leaving £50m outstanding "will slightly reduce the additional interest burden for Iceland, and enable it to further reduce gross debt by repaying the bonds with excess cashflow", wrote Lucror Analytics' Si Yong Ng. "We do not see any issues for Iceland to repay the remaining bonds outstanding ahead of their 2025 maturity, given our expectation that the company will generate positive FOCF [free operating cashflow] going forward and considering its robust liquidity, which we estimate to be c. £186m as at Q1/23–24 (pro forma for the transactions)."
The broadly leverage-neutral transaction, except for minor fees, will lead to net leverage of 3.5x based on underlying adjusted Ebitda of £199m in fiscal year 2023, which shows a lower indebtedness than when it last tapped the market in 2021 and net leverage was 4x, according to a company presentation.
Recovery story
The supermarket chain has struggled with high energy costs and stubbornly high inflation in the UK, leading to store closures and punishing bond prices in the secondary market.
The company noted that 2023 was a strong year for net sales – with fiscal year 2023 net sales up 6.9% to £3.959bn – though adjusted Ebitda was heavily impacted by higher energy costs, especially during the second and third quarters. Management pointed to a strong start to fiscal year 2024 with adjusted Ebitda of £34m in the first quarter, roughly double that in the same period of the previous fiscal year, due to strong trading, cost savings and a reduction in energy costs. Management also said they are highly confident in achieving Ebitda growth in fiscal year 2024, as they have already purchased more than 95% of the company's energy requirements.
"They're issuing a bond whilst they are on the way to recovery and that means the bonds probably have a lot of convexity embedded in them," the banker said, stressing their potential to trade up.
The rating agencies lifted their outlooks on Iceland's ratings.
Moody's affirmed Iceland's B3 corporate rating and changed the outlook to positive from negative on the expectation that the transaction will improve the grocer's liquidity, better prospects for its operating performance as well as expectations that it will bring down debt in the next 12–18 months towards a Moody's-adjusted debt-to-Ebitda ratio of 4.5x from 6.2x as of March 2023.
On July 20, Fitch revised the issuer's outlook to stable from negative, reflecting "an uplift in expected earnings from savings and more clarity on energy costs leading to forecast around 6.5x Ebitdar gross leverage in the financial year ending March 2024, meeting the rating sensitivity for a stable outlook".
Not refinancing the full outstanding amount of the 2025 notes is "credit positive and will reduce Ebitdar leverage to below 6.0x over the rating horizon, which will be more aligned with the 'B' rating category", Fitch wrote. "This will lead to slightly better Ebitdar coverage ratio than if it was fully refinanced."
S&P also revised Iceland's outlook to stable from negative on the view that "the group will continue to deliver earnings growth amid resilient demand". It noted Ebitda margins above 7% will result in adjusted debt-to Ebitda falling toward 4.5x–5.0x in 2024 from 5.7x in 2023, though Ebitdar coverage will stay at about 1.5x–1.6x due to increasing cash interest costs after refinancing.
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