For the retail and consumer product sector, the high yield market will likely remain an attractive source of capital.
The retail and consumer products sector has been deeply impacted by the COVID-19 pandemic, both due to physical constraints on brick-and-mortar stores and supply chains, and acceleration of existing trends favoring online purchasing and e-commerce. COVID-19 has reinforced the need to adapt to existing disruptions relating to how AI and data analytics can be deployed in the sector, advances in logistics, and the shift toward more engaged and responsible consumption.
While the long-terms effects of COVID-19 against the backdrop of an already shifting sector are still uncertain, it is clear that many retailers are under pressure: some have commenced restructuring, while others are facing a tougher liquidity environment. All retailers will likely need to further accelerate their omni-channel activity and adapt business models to new retail conditions. Economic conditions may also encourage consolidation (either in the context of restructuring or otherwise) or take-private activity. A high yield issuance may be an option to raise funds to support acquisitions, capital projects, or refinancing of indebtedness.
The high yield investor community is well-versed with different segments of European retail — including apparel and accessories, restaurants and food, and other consumer products and services. In 2019, a number of existing and new retailers issued high yield bonds to fund refinancings, acquisitions, and dividend recapitalizations. Investor familiarity with the sector will facilitate benchmarking and market access for new and existing issuers in the second half of 2020.
As market observers expect a strong retailer presence in the high yield market, below are five key considerations for retail and consumer product companies preparing for a possible high yield issuance:
- The team
Issuing companies can take a few simple steps in advance to ensure that the working group and internal teams seamlessly and effectively coordinate in the weeks leading up to a high yield issuance. These internal steps include:
- Surveying relevant precedents to position the company among its peers and considering the level of financial, operating, and industry information that peers have provided, as investors will typically be analyzing the company’s credit profile and business performance within the same context
- Assembling a dedicated team to prepare and respond to due diligence and backup documentation, review the offering memorandum and related presentations, and answer questions from rating agencies and other working group participants
- Staying in close touch with the issuing company’s external auditors who will be reviewing the audited and unaudited financial figures included in the offering document in order to provide “comfort” to the underwriters and board of directors of the company
- Financial information
The offering memorandum contains detailed information about an issuer’s financial position, including both audited financial statements and select non-IFRS financial metrics that will help an investor understand how the business performs. The issuer’s management will have an opportunity to provide commentary on the financial information, offering detailed explanations for changes in the company’s financial performance over comparable periods.
Retail companies should prepare to disclose:
- Three years of audited financial statements and interim financial statements of any quarterly period with a close fewer than 135 days from the closing date of the offering
- Pro forma financials on a case-by-case basis if the perimeter of consolidation has or is likely to materially change since close of the financial statements, for example, in connection with an acquisition or disposal that is material
- Recent trading information for any recent or stub period since the last interim period, if any, contained in the offering memorandum, which may be particularly important if the company’s sales have recorded a recovery since the end of confinement measures related to COVID-19
An issuing company may choose to disclose additional financial information by segments, such as region, product type, or channel. Often, the ability to include additional financial breakdowns is tied to the ability of the company’s auditors to “comfort” these breakdowns, therefore it is essential to discuss with auditors how to bridge such breakdowns to audited figures.
In addition to the financial statement presentation prepared in accordance with IFRS, retail companies should carefully consider the types of additional financial information that best align with their operations and would present a clear picture of their business. Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a non-IFRS metric typically used in debt financings as a proxy for cash generation. Retail companies may consider reasonable and factually supported adjustments to their EBITDA to help investors understand the company’s ability to generate cash following non-recurring events, among other matters. In the past, retailers have adjusted EBITDA to reflect changes in perimeter (adding/removing the impact of acquisitions and disposals), restructuring costs, run-rate adjustments for new stores or store refurbishments, and realized or unrealized foreign exchange rate changes related to procurement. Moving forward, EBITDA adjustments relating to the ramp-up of online or takeaway operations implemented in response to COVID-19, or adjustments of negative EBITDA from COVID-19-related store closures, may also be appropriate. Retail issuers should be in a position to back up adjustments to EBITDA with appropriate data or models.
- Operational metrics
Retailers should prepare to provide a full description of their business operations across key performance indicators (KPIs) over comparable periods, providing investors with a complete understanding of how the business operates. Issuing companies should carefully choose this disclosure based on the KPIs they consistently and reliably collect and track as part of their business operations. Common KPIs for retailers include:
- Number of points of sale (POS)
- POS or online conversion rates
- Sales per square meter
- Average transaction value
- Units per transaction, or customer retention
Retailers that may have experienced a COVID-19 related surge in online activity may want to develop, track, and report additional e-commerce operational metrics.
Operating metrics should also contextualize the retailer in its market, benchmarking the retailer’s performance against other players in the same industry. Retailers may consider obtaining relevant reputable industry reports prepared by recognized management consultants or similar experts for citable industry data with future forecasts in the segments and geographies where they operate. Such reports can be helpful in supporting factual statements and market data in the offering document.
In addition to providing key disclosures in the offering memorandum, the operational metrics that retailers ultimately choose to disclose will serve a critical role as part of the marketing process during the investor roadshow presentations.
- Compliance policies and environmental, social, and governance (ESG)
Underwriters and investors will be particularly focused on ensuring the issuing company is in compliance with applicable law and regulations, and that the company is engaged on ESG matters. Retailers should be prepared to respond to questions about their historical compliance with trade sanctions, as well as anti-corruption and anti-money-laundering regulations. Issuers will also be asked to contractually warrant their compliance with such regulations. Retail companies may encounter additional compliance questions related to fair labor standards, supply chain controls, and environmental and sustainable sourcing. In anticipation of such questions, issuing companies should be prepared to provide evidence of documented internal policies that have been distributed throughout the company, and to demonstrate historical compliance with these policies. Issuing companies should also be prepared to disclose and explain any historical failures to comply with such policies and, ideally, to accompany such explanations with remedial steps taken to address those failures, and ensure future compliance.
- Description of the Notes
The Description of the Notes is a section of the offering memorandum that describes the contractual terms of the high yield issuance, including the agreed-upon covenant package. Most European retail high yield deals are structured as senior secured notes with an accompanying super senior revolving credit facility to provide the retailer quick access to liquidity. While retailers have brought other structures to market, such as senior secured notes with a pari passu term loan or a combination of senior secured and senior subordinated notes, each structure has implications for the guarantee and collateral package, and the differing constraints and flexibilities that such a capital structure affords.
In anticipation of negotiating the covenant package, issuing companies should identify the company’s current and anticipated liquidity needs, building in some headroom and flexibility to accommodate future business plans. Flexibility may be particularly relevant for retailers in connection with asset sales (providing the retailer with the ability to divest certain non-performing retail locations), liens (ability to grant security over assets securing the high yield notes and/or other unencumbered assets), investments (allowing the retailer to make non-controlling investments in similar businesses and provide financial assistance to franchisees), indebtedness (debt capacity at subsidiary levels to promote local currency borrowing), and hedging (to permit operational hedging sharing the same security package as the high yield notes). Retailers may seek covenant flexibility if such flexibility will help facilitate their specific long-term strategies and allow them to further their business goals.