Are bonds back in fashion?

UK retailers Next and Tesco have returned to the bond markets, attracting a significant amount of investor interest. Laura Gallacher considers the next likely candidate.

Over the Easter period, we have seen a return to the bond markets from UK retailers, with both Next and Tesco issuing debt for the first time since 2016 and 2009, respectively.

Retailers have had a tough time in the intervening period, with no meaningful signs that the long-standing structural pressures facing the industry are easing.

However, such has been the strength of the sterling bond market in recent weeks (compounded by a lack of issuance) that investors have been largely willing to overlook these challenges, and support the refinancing activity of UK retail. 

Next came just before the Easter break with a six-year £250 million deal, of which £50 million was retained. The initial price talk offered a meaningful concession to where secondary bonds were marked, but quickly tightened to levels that fully reflected the quality of the name.

Next is well placed to deal with the current industry difficulties, particularly with a strong online presence helping offset declines in the physical stores.

However, we still have concerns that clothing is a sector that could continue to feel pressure should we see any fall in consumer discretionary spending this year, and we are already seeing some evidence of this elsewhere on the high street.

The company is committed to an investment grade rating - currently mid-BBB - and has a relatively strong balance sheet, with scope to facilitate regular share repurchases that continue apace.

Despite Next’s relatively strong credit metrics, it is notable that the company didn’t offer any investor protection from a future deterioration in trading and worsening of credit metrics, (with no coupon step-up language on a downgrade to high yield) which would have allayed some downside risk for investors.

So why didn’t we buy the bonds? A combination of concerns over what appeared to be an aggressive pricing, and fears over a further deterioration in high street activity meant that we were happy to pass.

Returning from the Easter break, Tesco announced a new deal – presumably having seen the favourable market response to Next - issuing in the sterling market for the first time in a decade with a six-year £400 million bond.

Proceeds from this deal are to be used to finance a concurrent attractive tender offer for its fixed-coupon sterling bonds, and a euro-denominated 2020 bond.

Once again, an attractive initial price talk attracted a significant amount of investor interest, with orders placed from investors in excess of £3 billion.

Tesco’s recent progress in reducing leverage and improving profitability has been recognised by investors, and there is a belief that a return to an investment grade rating is a realistic target for the company to achieve over the next 12 to 18 months.

In terms of identifying the next likely candidate to come to the market, M&S has a £400 million issue falling due in December this year. I’m sure that they have been keenly watching their peers and considering the timing of their next deal carefully.

Laura Gallacher, fixed income investment manager, Kames Capital.

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