Executives at some companies in retail and other consumer-focused industries are racing to assess their capital needs and business plans amid the sharp drop in the British pound over the past year, recent market volatility and rising interest rates.
The pound, which has done a round-trip in recent days after the U.K. government said it would cut taxes before partly reversing course Monday, remains down about 17% from a year earlier at around $1.13 versus the dollar, pressuring companies that have to pay more for their imports. The Bank of England has raised rates seven times since December, bringing them to a level of 2.25% last month, which is further squeezing highly leveraged companies.
The tumult has left businesses unsure of the size of their liquidity needs or whether they can hold out from borrowing new funds to stay afloat as they hope for markets and the currency to recover. It has also driven up costs for certain credit-default swaps that investors take out to insure against the default of bonds they own.
Companies in consumer-facing industries, such as retail, consumer goods and hospitality, will likely be hit most if spending slows and the U.K. economy enters a recession, as forecast by the Bank of England. “We expect some companies will be more prudent with, for example, reducing their capital expenditures and moderating hiring plans,” said
Gareth Williams,
global head of corporate credit research at S&P Global Ratings, a ratings firm.
Many companies in recent years took advantage of low interest rates and refinanced cheaply. Still, there is more than $36 billion in U.K. corporate debt coming due this year, followed by $221.11 billion next year, according to Dealogic, a data provider.
U.K. retailers are in the spotlight, as some of them are heavily leveraged and their bonds carry some of the highest yields in the junk-bond market. Credit-ratings firm
Moody’s
Investors Service last week warned that rising interest rates would result in higher debt servicing costs for Wm Morrison Supermarkets Ltd. and Bellis Finco PLC, the entity behind supermarket chain Asda Stores Ltd.
In Morrison’s case, this will likely weaken the company’s credit quality from its current rating of one level below investment grade. More than half of Morrison’s debt has floating rates and no interest hedging in place, which means that the company’s interest expense excluding lease interest will increase to about £335 million per year—equivalent to about $377 million—up from £300 million, Moody’s said. Morrison declined to comment. Asda said the change in interest rates has a limited impact on its financing costs.
Meanwhile, debtholders of grocer
Marks & Spencer
Group PLC on Sept. 30 had to pay an upfront fee of 15.89% plus a coupon of 100 basis points of the amount they wanted to insure with a swap, up from 12.36% on Sept. 9 and 11.15% at the beginning of August plus respective coupons, according to
Intercontinental Exchange Inc.,
which operates exchanges and clearinghouses.
The cost of protecting debt issued by other companies, including aircraft engine manufacturer
Rolls-Royce
Holdings PLC and
J Sainsbury
PLC, a supermarket chain, also went up in recent weeks, ICE data shows. The three companies didn’t immediately respond to a request for comment.
Distress levels at U.K.-based companies rose 9.7 percentage points in August, the latest available data, from the prior-year period, according to the Weil European Distress Index, which looks at company valuations, changes to credit default swaps, dividend yields and other metrics. “Surprisingly, distress is also rising among large corporates, which weren’t as impacted by the pandemic,” said Andrew Wilkinson, a partner at law firm Weil, Gotshal and Manges LLP, adding that large companies will likely face more pressure in the fourth quarter. Companies need to make sure they have access to adequate liquidity and delever before interest rates go up further, he said.
As the macroeconomic environment becomes rougher, U.K. companies in financial distress are expected to use more bespoke transactions to refinance debt or find new financing sources, said
Matthew Czyzyk,
a London-based restructuring lawyer at Ropes & Gray LLP, a law firm.
Liability-management deals that favor some lenders over others to create financial breathing room for businesses have become increasingly popular in the U.S. in recent years as private-equity firms look for ways to bail out troubled portfolio companies. Those same deal structures could now arrive in the U.K., Mr. Czyzyk said.
“The banks are very fast to put the rates up for companies,” said
John Neill,
chairman of Unipart Group Ltd., a logistics, manufacturing and consulting firm in Oxford, England. The company, which has limited outstanding debt, has locked in some rates, while others are floating.
Highly leveraged U.K. businesses will likely focus on managing their costs and protecting their operating margins, said
Ed Eyerman,
head of the European leveraged finance unit at Fitch Ratings. “The near-term default risks are getting higher for anybody with floating rate debt and maturities before 2025,” Mr. Eyerman said. Fitch forecasts European defaults will rise to 3% in 2023, up from 2% this year.
Leveraged U.K. companies should focus on improving cash flow and consider reducing spending on capital expenditures, a corporate banker said. “We are advising them to look at alternative funding sources,” the banker said. “Private credit is a financing option that should be considered.”
Sixty-four U.K. companies issued profit warnings in the second quarter, up 50% compared with the prior-year period, a trend that is expected to have accelerated in the third quarter, said
Alan Hudson,
who heads up the U.K. and Ireland business at EY-Parthenon, the strategy arm of the professional services firm. “With the sheer amount of uncertainty in the market, it is increasingly difficult to forecast,” Mr. Hudson said. “We are seeing an increase in multiple warnings by the same companies, which is often a precursor to restructurings.”
Nine U.K.-based companies, such as subsidiaries of Iceland Foods Ltd., the grocery chain, and online-payments provider Paysafe Ltd., have been hit with bond downgrades since July, data by S&P, Moody’s and Fitch show. “We are expecting the more difficult operating environment to lead to more rating actions,” S&P’s Mr. Williams said. Paysafe declined to comment and Iceland didn’t respond to a request.
On top of that comes the weakening of the pound against the dollar. “The situation makes executives step back and reassess: Is this a permanent move?” said
Eric Merlis,
a managing director at
Citizens Financial Group Inc.,
noting an increase in client inquiries about hedging. Even businesses that have protected themselves against sudden currency movements through hedges over time will see an impact, he said.
PLC, the owner of fast-fashion chain Primark, is facing higher costs for clothing, which is denominated in U.S. dollars, alongside fuel, according to
John Bason,
the company’s finance director. ABF’s earnings from the U.S., where it operates some stores as well as food businesses, provide it with a translation benefit, he said. “But this benefit is smaller than the transaction effect at Primark,” Mr. Bason said.
Unipart, however, expects to benefit from the changes in the pound. “In recent months, we got a 20% to 25% boost in competitiveness against our rivals in the U.S.,” Mr. Neill said, adding that the company generates about $50 million in annual revenue in the U.S. But that benefit could be short-lived, Mr. Neill said, pointing to U.K. inflation that is forecast to hit 10% later this year.
“In the long run, you always lose if you have a weak currency,” he said.
—Mark Maurer, Andrew Scurria and Alexander Saeedy contributed to this article.
Write to Nina Trentmann at [email protected]
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