Myer is in danger of a debt default next year, warns UBS

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  • Myer is at risk of breaching two out of three debt covenants in the 2019 financial year, UBS says.
  • The analysts forecast earnings to fall by 7% per year over the next three years.

UBS says Myer is at risk of breaching its debt covenants in the 2019 financial year, following yesterday’s disastrous half-year results.

Huge impairment write-downs were the main driver of Myer’s $476.22 million loss for the six months to December, as the company also reported a 4.2% drop in sales.

A string of poor results has brought Myer’s existing debt structure into focus, although UBS said a covenant breach is still unlikely in the 2018 financial year.

“In our view, however, risk of a breach in the 2019 financial year is high, unless a material improvement in Myer’s profitability is seen,” the analysts said.

This table shows Myer’s three existing debt covenants, two of which UBS says are at risk in FY19:

Of the three, UBS says Myer’s Fixed Charged Cover (FCC) has been the covenant viewed most at risk.

An FCC measures a company’s ability to pay all of its fixed debt obligations out of income earned (before interest and tax charges).

UBS says an FY18 breach of the FCC covenant would required like-for-like (LFL) sales growth to fall by 8% — well in excess of the UBS estimate of -1.7%.

However, in the 2019 financial year a fall in LFL sales growth of just -2% will trigger a debt breach, UBS said.

The shareholder equity covenant is also at risk given yesterday’s asset write-down of over $500 million, which was reflected in a commensurate fall in equity.

In addition, “post-impairment intangible asset growth and profitability assumptions still look optimistic”, the analysts said.

UBS forecasts Myer’s earnings will fall by around 7% per year over the next three years.

They said sales growth is unlikely in the short-medium term due to: Weaker consumer spending, a structural shift out of department stores and the threat of Amazon — “Myer’s major categories are most exposed to Amazon” — and fast-fashion retailers such as Zara.

“We believe Myer needs to shrink to greatness to address structural challenges and become a more targeted, nimble and profitable business,” UBS said.

“That said, it is costly and we do not believe the balance sheet — as it stands today — can support this.”

UBS said Myer needs to reduce space, with a large portion of stores only breaking even or dragging on margins. But that would involve the renegotiation of Myer’s onerous lease contracts with significant up-front costs.

Operationally, UBS said Myer needs to invest in its online capacity, reduce its product range and use data to effectively focus on exclusive, demand-driven products more suited to an in-store experience.

“The challenge with the above in our view, remains the pace and cost at which it can be done given the large number of stakeholders involved,” UBS said.

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