One section of the European high yield market that has materially under-performed this year is the UK retailer and food producer complex. The rationale is fairly easy to explain: these companies are being squeezed by cost input inflation on one side (cotton, grain, cheese, sofas, whatever it is, it’s more expensive to source) and on the other side, the end customer (the UK consumer) has less money to spend. Result – your sales and profitability suffer and the company’s ability to service its debts deteriorates. The increased credit risk is reflected in higher bond yields. Add to this the fun and games surrounding the European sovereign crisis and it’s easy to see why these names have suffered from the “sell first, ask questions later” knee jerk response of the market when risk appetite wanes.
As I was reclining on my DFS sofa the other day it struck me that these mini non-discriminatory sell-offs often create opportunities. Any good high yield fund manager should always be looking for a bargain, whether he/she is buying a new suit in Matalan or looking to deploy capital in the credit markets. So one question we are grappling with at the moment is this: amongst the beaten up high yield UK retailers and food producers, are there any good deals to be had?
In my view, the answer lies in good old fashioned credit analysis. Looking at each company’s business model. Asking questions like “is this business model viable?” and “are there long term structural issues in the age of online shopping?” Analysing what is driving the top line, what is happening to costs, and crucially for any credit investor, looking at cash flow in this challenging environment and how resilient this cash flow is likely to be in relation to the company’s debt.
If we can find a company that can weather the current storm on the UK high street with its capital structure intact and buy some of their bonds at double digit yields, then this could be a great opportunity.