Friday Workout - 4 December

Gray Rhinos, Goldilocks and No Bears, Retail Cheque-Outs

By Chris Haffenden | Editor |

The latest ‘melt-up’ in risk assets and its rationalisation reminds me of John Templeton: “Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.”

I think we are in a ‘rational exuberance’ stage. 

The consensus narrative is we are riding on a wave of financial asset inflation driven by QE and government largess with strong economic growth just around the corner from the vaccine.

But this grey-haired former trader is wary when there is such strong conviction. The consensus can be often wrong. If everyone is long and asset-prices are super correlated, who is left to buy?

My concern is that 2021 could be the year of ‘irrational complacency’. 

Bank of America’s Thundering Word report talks about an uber-Goldilocks consensus for the economy for 2021 with strong growth with expectations that rates will remain extremely low. 

But what are the potential risks to this Goldilocks and no bears scenario?   

Rather than look for Black Swans, I would recommend searching for Gray Rhinos.

Highly probable, high impact, yet neglected events.

Michele Wucker – who coined the idea, says, “we don’t pay enough attention to the big obvious problems that are in front of us.” Many Gray Rhinos are hidden in plain sight and could charge. 

BofA recommends to ride the wave into the reopening but look to sell as the vaccine euphoria fades. It favours HY over IG, EM over SPX, CRE over housing and rotation into small caps and value to growth. But their risks to their Uber-Goldilocks base case look like Gray Rhinos. 

Such as the resurgence of inflation (remember, this is what Central Banks are targeting) and higher risk-free bond yields. Perhaps driven by supply bottlenecks in goods and services?  

Higher interest rates could dent the dash for trash narrative and hurt DCF valuations. 

Effects from disorderly moves in the US dollar (short $ is the most crowded trade) is another potential Gray Rhino, in particular for those doing business in Emerging Markets. 

My most likely Rhino is the vaccine fails to spur expected growth and/or the immunity timeline and the economic recovery is delayed. Corporates may fail to increase capex and employment enough on reopening and default risks rise as fiscal stimulus fades and employee benefits and moratoria expire. Focus shifts to addressing the debt built-up during the pandemic. 

Spotted in the distance are other Rhinos. One is a backlash against the winners from QE, as BofA notes: “Never in the field of monetary policy was so much gained by so few at the expense of so many.” Are we due a transfer of wealth back from Wall Street to Main Street, either via taxation or regulation? 

Another Rhino is the return of the public sector at expense of the private sector. 

You might be asking yourself why has the Friday workout gone on Safari this week? 

In our world of distress and restructuring, it is sometimes worth looking beyond the consensus and current direction of travel and use our peripheral vision to identify existential threats.  

Most advisors had their busiest year since the GFC in 2020. Deals already on their books suddenly became more urgent with onset of Covid. Sponsors proactively shored-up portfolio companies, first by launching a plethora of waivers, then using loopholes and baskets to inject liquidity. But some decided in early summer they must embark on meaningful restructurings for deals such as Swissport, but as one advisor recently said most summer business plans are now in the bin, as their projections were all wrong.

The spring consensus was that as government support schemes were wound down in the autumn, this would be the trigger for a second wave of distress. But that didn’t happen. Initiatives were extended into next spring and even though the second corona wave has impacted revenues somewhat, the sharp rally in secondary HY prices and ability to refinance stressed businesses has held back the tide. 

Ample liquidity buffers with no near-term triggers is the consensus investor view for most stressed names, which is helping prices rise into the 90s. But even if EBITDA eventually recovers to 2019 levels, in 2022/23 the deleveraging will be slight and will be coming from a much higher base than 2019.

Healthy liquidity levels don’t tell the whole story. Most CFOs spent most of 2020 cutting capex to bare maintenance levels, while banking the benefits from working capital management, deferred taxes and rent holidays, plus saving employee costs via furlough. Rebooting operations could have a disproportionate impact on liquidity as working capital reverses and deferred payments come due and worker costs increase. 

CFOs mentalities must change in 2021. It’s time to devise post-Covid business growth plans and ask whether their debt structures are still appropriate. The key question is do they have enough time to find a growth path before the refinancing wall appears? 

Retail cheque outs

There was one sector this week trampled by a stampeding Rhino – UK Retail. 

Arcadia’s insolvency filing caused a domino effect amongst names such as Debenhams. 

This i-message I received on Monday neatly sums this up well. 

But as Richard Lim from Retail Economics predicted on a Kirkland & Ellis Retail webinar yesterday (3 December) many more will follow. Structural changes seen over the past decade have accelerated in last 7-8 months and many retailers will stand or fall on the strength of their digital platforms. 

Department stores failed to make the transition. Too many properties, too much floorspace and restrictive leases. Customer journeys are changing rapidly. Our analysis says 45% of people are making first time purchases online for products where their only purchases were in a store, said Lim. 

Going forward the emphasis will be on brand awareness with consumers doing research online and as well as focusing on digital point of sale, fulfilment, service and how returns are handled are important factors. Social Media influences will be the main factor – Zara already has 41m Instagram followers. 

How well are our EHY retailers coping with their digital transitions? Douglas is cited as a winner by investors but may still struggle to refinance without sponsor support. Matalan divides opinion - its online offering is poor – but its stores may benefit from the closure of other UK retailers in the short term.

Iberia dominated European distressed news this week. 

Spanish Grocery Group DIA announced this week that it had secured lock ups with lenders to a recapitalisation plan. Syndicated lenders will extend €902m of loans from March 2023 to December 2025. DEA Finance owned by significant shareholder LetterOne will equitise a €200m super senior loan and also equitise €300m April 21 notes – purchased at a discount via a tender in August. The €300m of 2023 notes bought at 60 in April will be extended from April 2023 to June 2026. 

Naviera Armas announced a forbearance agreement (with undisclosed expiry date) with an ad hoc committee representing over 72% of the 2023 and 2024 FRNs. The troubled Spanish Ferry operator missed coupon payments on 31 October and 15 November and is reportedly seeking around €100m from SEPI – the government fund for strategic businesses. Bondholders are also mooted to provide short-term funds, but the current collateral package is poor, and they will likely demand changes, according to a source close to the bonds. (9fin will be providing a more detailed update next week)

TAP Air bonds rose over 20 points into the 70s, in hopes for more state aid. The Portuguese airline has to submit a restructuring plan to the European authorities by 10 December. Local press reports suggest the fleet will fall to 85-90 from 120, with staff cuts of around 20%, but that its “obligations will not be hit.” 

Prisa avoided an English scheme of arrangement to implement their amend and extend, with 100% of lenders approving the plan. The A&E refinancing sees debt maturities extended until March 2025, with €400m of debt repaid with its Santillana Spanish business to be sold for €465m.

Finally, a few headlines from 9fin’s distressed coverage

Aryzta appoints Houlihan Lokey as FA, to raise €600-800m via disposals to deleverage (9fin) 

Norwegian Air Shuttle to propose significant equitization of liabilities and launch NOK 4bn rights issue (9fin)

WiZink PIK toggles rise on ECJ usury case hopes, but upstream dividend concerns remain (9fin)

Hurtigruten exploring new facilities to provide headroom, Significant Liquidity Event from Svalbard Real Estate sale (9fin)