Morrisons, Asda face high cost of their debt-fuelled buyouts

Bloomberg

When the UK supermarket chains Asda and Morrisons were taken over last year, their private equity buyers took the typical step of piling them with debt. Now, that burden is becoming increasingly heavy as soaring inflation squeezes incomes, shoppers tighten their belts and borrowing costs soar.
The UK’s third and fifth-largest supermarkets are facing combined annual interest bills of more than $805 million, according to analysts at Moody’s Investors Service. Covering those debt costs is a tough task in the UK, where intense competition among the big chains reduces their ability to raise prices.
Instead, grocers are having to attract increasingly frugal shoppers with budget offers that erode their margins.
Morrisons’ most recent financial report showed a 50% slump in adjusted earnings. Previously the number four supermarket, it was recently overtaken by German discounter Aldi. While less than Morrisons, Asda is also feeling the pressure, with like-for-like sales falling for two straight quarters.
On top of the increased competition, the debt burden is an unwanted additional pressure that bond investors are now starting to price in, according to Gordon Shannon, a portfolio manager at Twenty Four Asset Management. Yields on the debt of Morrisons and Asda are more than double those of rival Tesco.
“This cycle we’re going to see a lot more divergence between names,” Shannon said.
The billionaire Issa brothers and private equity firm TDR took control of Asda in early 2021, while Morrisons was bought by Clayton, Dubilier & Rice at the end of that year. As is typical with such deals, both buyers added debt onto their targets; but this was done during the pandemic era when interest rates were at rock bottom.
“Those issuers that have loaded up on debt and were hoping they could refinance where they were last year are going to struggle,” said Colin Ellis, a global credit strategist at Moody’s. “There is a good reason why those with stronger balance sheets have a higher degree of resilience when shocks happen.”
Asda’s annual interest bill amounts to £400 million, while Morrisons is set to rise to £335 million. The latter is particularly vulnerable to rising interest rates as over half of its debt is floating and unhedged,
according to Moody’s.
As consumers feel the pain and supermarkets’ profits shrink, one metric in the spotlight is the ability to service interest bills through earnings. Earlier this year, Moody’s expected the interest coverage ratio for both firms to be below 2 times between 2022 and 2023. Tesco, by comparison, is seen at 3.4 times.
A spokesman for Morrisons declined to comment. Asda said it’s using interest rate swaps to convert floating rate interest to fixed so the impact of increasing base rates is “marginal” on interest costs. The retailer’s capital structure matures in 2025 which provides “certainty and stability” in the medium term.
For retailers, there’s little sign that the tough backdrop will get better anytime soon. Economists in a Bloomberg survey say the economy is in a recession that will last until the middle
of 2023, and inflation will
only slowly come down from its elevated levels.
Yields on Asda and Morrisons debt, which represent the borrowing costs if they come to market, have risen far more sharply than for Tesco. Asda’s bonds maturing in February 2026 are at 10.49% while Morrisons’ November 2027 bonds are near 12%. That compares with 4.37% for the May 2026 bonds of Tesco.
This suggests that the interest bill would increase even more when these bonds come due for refinancing, if rates don’t ease off by then.
Both retailers have sold some properties under private ownership, with Asda raising £1.7 billion for its warehouse sites. Morrisons is pursuing a sale and lease back of five stores to raise £150 million, The Times has reported, in addition to another transaction involving manufacturing sites for more than £500 million.