Primary Analysis: Eroski SSNs 10% Price Whisper Above Peers Reflects Debut Issuer Premium, Checkered History, Thin Cash Generation; Recently Improved Margin, Market Position Among Positives

Relevant Items:
Prelim. Offering Memorandum
Covenant Analysis
Historical Financials on Fundamentals by Reorg
 

Eroski, S. Coop. - €500 million Senior Secured Notes due 2029
Sector	Consumer Staples Distribution & Retail
Sub-Sector	Food Retail
Sponsor/Ownership	Employee & Consumer Cooperative
Issuer Rating (M/S&P)	B2 / B+
Issue Rating (M/S&P)	B2 / B+
Call Protection	NC2 / 50 / 25 / Par
Change of Control & Portability	101% put option upon a Change of Control, no portability

 
Spanish supermarket chain Eroski is marketing €500 million senior secured notes due 2029. The proceeds, together with a €112.8 million new term loan A due 2029, €35 million proceeds from the disposal of properties and €80 million cash on balance sheet, will be used to refinance €702.8 million of existing syndicated loan, as well as accrued interest and transaction expenses.

Atypically, the maturity of the new 2029 notes can spring to July 31, 2027, which is 6 months before the maturity of the group’s subordinated Obligaciones Subordinadas Eroski, or OSEs, due Feb. 1, 2028, should OSEs not be repaid or refinanced by July 31, 2027.

The nominal amount of the group's existing syndicated loan totaled €873.6 million as of July 31, of which €18.5 million has since been repaid with proceeds from real estate disposals and €152.3 million is to be written down on or about the issue date, leaving €702.8 million to be repaid with cash.

In 2014, Eroski had a debt pile of €2.6 billion driven by debt-funded expansion, largely attributable to its acquisition of Caprabo SA in 2007 for about €1.7 billion. In January 2015, Eroski extended its €2.6 billion debt by four years to 2019, following which the group has repaid a portion of the debt with asset disposals. The amount was then reduced to €1.531 billion in 2019, and extended again to July 31, 2024. Since then, the group has paid off €519 million with cash and written off €157 million. As mentioned, as part of this transaction Eroski will write down another €152 million principal amount (more details in “2019 Restructuring” section).

It should be noted that the €35 million proceeds from disposal properties, included in sources of funds for this transaction, are temporarily financed by an 18-month bridge loan, which is to be repaid from sale proceeds from a portfolio of real estate assets expected to be divested. The properties expected to be disposed of include commercial premises such as supermarkets, hypermarkets (one site currently under development), two gas stations and three real estate properties, covering 196,814 square meters in aggregate. These properties do not form part of the collateral (e.g. shares, bank accounts and intra-group receivables) securing the notes, the new term loan A and the bridge loan. However, the bridge loan benefits from additional security in the form of first-priority mortgages over these properties.

The group also has new and extended working capital facilities due 2026 for a total of about €293 million pro forma for the transaction (more details in “Pro Forma Capital Structure” section below), which rank pari passu with the new notes and the new term loan A, and are treated as trade payables under IFRS. About €151 million is currently drawn out of the total €293 million total available amount, according to S&P Global Ratings.

Pro forma adjusted EBITDA pre-IFRS 16 for the LTM period ended July 31, 2023 amounted to €312.7 million. The pro forma figure is calculated by adjusting the reported adjusted EBITDA pre-IFRS 16 of €314.3 million up by €1.1 million, reflecting the full year impact of sale of Viajes, and down by €2.7 million reflecting the full year impact of real estate asset disposals.

The marketed pro forma net leverage pre-IFRS 16 is 2.5x, based on a net debt figure which includes OSEs but excludes the €35 million bridge loan, working capital facilities, as well as subordinated perpetual Aportaciones Financieras Subordinadas Eroski, or AFSEs. The group said it targets to reduce its pre-IFRS 16 net leverage to below 2x in the near to medium term. Reorg calculates a pro forma net leverage ratio of 3x including all the aforementioned debt obligations in total net debt, except for the working capital facilities and the equity portion of AFSEs (more details in “Pro Forma Capital Structure” section). The ratio is 3.4x after accounting for the €108 million equity portion of the AFSEs.

Of its €287 million real estate properties owned by the group, about €260 million assets are viewed as non-core (including about €19 million of realized asset sales and about €35 million of planned real estate asset sales), of which only 10% are used by the group as shops, for example. Eroski said it is able to sell non-core assets at attractive valuations for deleveraging or reinvesting purposes.
 
Price whispers for Eroski’s new notes are at 10%, above the 8% average current yield of European grocers’ comparable issuances, as shown in the table below. This does not come as a surprise, as we expect Eroskiʼs SSNs to pay a premium given the groupʼs small size, checkered history and the fact that it is a first-time issuer.

Other similarly rated, fixed rate, euro-denominated notes that recently priced in the 9% to 10% range include: Italy-based global furniture and lighting company International Design Group (10%); Spanish energy transition solutions provider Amara NZero (10.25%); Italy-headquartered chemicals group Polynt (9.5%) and debut issuer German automotive component supplier Benteler (9.375%). See our primary analysis on International Design Group HERE, Amara NZero HERE, Polynt-Reichhold HERE, and Benteler HERE.

With Eroski’s business being in the consumer staple field, which is defensive in nature, in contrast to International Design Group, Benteler and Polynt’s more cyclical businesses, we think a 10% yield is fair in compensating for Eroski’s weak credit history and ownership structure. Indeed, Eroski has been at odds with its financing partners over the last decade, as discussed at the bottom of this article. Given the debt write down to refinance this deal and the maintenance of the cooperative structure, which has bothered lenders involved in this name, the 10% yield is just about enough to compensate investors for the issuer’s checkered history, in our view.

As comparables, Reorg selected single B rated euro-denominated bonds issued by European food retailers, including U.K. grocery retailer Morrisons, U.K. frozen food retailer Iceland, and French frozen food retailer Picard. The average current yield of the peer group amounts to about 8%.

Eroski has the lowest net leverage through the SSNs at 1.7x among peers, compared with 2.3x for Iceland, 4x for Picard and 4.6x for Morrisons. Eroski’s LTM levered free cash flow after leases margin of 0.3% is in line with Iceland’s, but lower than 1.2% for Morrisons’ and 3.5% for Picard, although Eroski’s margins were negatively impacted by a €127 million working capital outflow over the last 12 months.

   
Investors considering Eroski’s new notes were cautious, citing a number of risks related to the credit, in particular the company’s complicated track record involving its debt restructuring in 2019 and concerns that relatively high EBITDA margins may decline as inflation recedes over the coming months.

Eroski was more aggressively managed before the global financial crisis, with the company making substantial debt-funded investments in real estate, which resulted in leverage rising to 10x in 2013. But since then, the company has made a number of asset sales and completed a debt restructuring, buysiders said.

According to the company, leverage declined to 2.5x on a pro forma net basis, however the actual figure may be higher, investors highlighted. Eroski has consolidated the entire EBITDA of subsidiaries owned as part of a 50/50 joint venture, buysiders said. However, adjusting for this only results in a 0.7x increase in leverage, one investor noted.

The group’s EBITDA margin is among the highest in the sector, having risen to 5.8% for fiscal 2022 on an adjusted pre-IFRS 16 basis and 6.2% for the LTM period to July 31 from 4.4% for 2014. However, sources agreed that this will most likely decline as inflation subsides and as consumers become aware that inflation is improving, particularly considering the highly competitive pricing practices in the supermarket space.

Eroski told investors that it passed through 70% of cost increases to customers, however it is likely that prices have increased more than costs, one buysider explained. This is reflected in an increase in gross margin per square meter for the group, he said. According to the group’s presentation, pre-IFRS 16 EBITDA per store improved to €0.21 million for the LTM period, from €0.16 million and €0.17 million in fiscal year 2021 and 2022, respectively. This increase could have been achieved by increasing volumes or improving the product mix. However, these alternatives are unlikely, which means prices paid by Eroski’s customers have most likely been rising faster than the cost of goods sold, which may not be sustainable, the investor said.

The company also seems to have been losing market share, investors said.

Investors noted that on the 50/50 Supratuc joint venture with Czech fund EP Bidco, Eroski has fully consolidated EBITDA because under certain circumstances, when a disagreement occurs between directors appointed by each of the JV members, Eroski’s director has the right to cast the deciding vote. However, investors highlighted that when this right is exercised by Eroski, the JV partner is entitled to exercise a put option to sell its 50% stake to Eroski at market value, and Eroski has up to one year to buy it.

Whispers are at 10% for the new notes. This level of interest costs will erode a significant amount of the company’s free cash flow, however Eroski will have to accept this given that part of its existing debt is due in 2024, investors said.
 
Sources and Uses of Proceeds
 

Source: Page 82 of the OM pdf

Pro Forma Capital Structure
 

The group’s €15 million unsecured Supratuc debt and €17.8 million unsecured local loans are issued by non-guarantor subsidiaries belonging to the restricted group, hence Reorg treats these debts as structurally senior to the new notes, the term loan A and bridge facility.

There are also working capital facilities due 2026 for a total of about €293 million pro forma for the transaction, including:
 

• €80 million guarantee facilities
• €10 million comex facilities
• €153 million confirming lines for Elorrio
• €25 million confirming lines for Supratuc
• €8.85 million guarantees lines for Supratuc
• €16.2 million guarantee lines for Vegalsa

These Confirming and Guarantee facilities for working capital purpose rank pari passu with the new notes and term loan A, and are treated as trade payables under IFRS. About €151 million is currently drawn out of the total €293 million total available amount, according to S&P. Reorg’s capital structure above doesn’t include these liabilities.

The group’s unsecured “Loan 15” due 2028 was issued by Cecosa Hipermercados, SL, which is a guarantor of the notes. The group expects to pay €13.4 million of its entire capitalized interest cost on Jan. 31, 2024 pursuant to the terms.

In addition, the group has two subordinated instruments: €209 million subordinated OSEs due 2028, and €232.8 million (net of €47.2 million held by the group) subordinated perpetual AFSEs, which both remain outstanding after the transaction. The OSEs were issued through an exchange offer from AFSEs in 2016 and are subordinated fixed income securities (valores de renta fija).

The group said it estimates the minimum cash to operate its business is €70 million at consolidated level. Pro forma for the transaction, its cash position would be €144.6 million.
   

Source: Page 35 of the OM pdf
   

• Strong market position in the resilient but highly competitive Spanish grocery retail market: Eroski, with about 1,500 stores, is the largest food retailer in Northern Spain (Basque Country and Navarra). It is the fourth largest food retailer in Spain based on sales with a 4.4% market share as of Aug. 10, 2023 according to Kantar, behind 27.2% for Mercadona, 9.7% for Carrefour, and 6.2% for Lidl. Eroski has lost 30 bps market share since the end of 2018, according to Kantar, but in its presentation the group said it gained 10 bps market share between 2018 and 2022 based on Euromonitor.
  
  About 90% of the group’s EBITDA is generated from core regions where it has leading market positions. The market shows limited sensitivity to macroeconomic conditions and allows cost-pass through to customers in inflationary periods, during which Eroski’s retail sales price for food products has generally increased at slightly higher levels than inflation.

• Deleveraging prospects supported by new prudent financial policy and non-core asset disposals: Adjusted net leverage for the group fell to 3.5x in fiscal year 2022 and further to 2.5x as of July 2023 from 10x in fiscal year 2013 pre the 2015 and 2019 restructuring, driven mainly by asset disposals, debt writedown and cash generation. To delever the business, Eroski divested €1.5 billion non-core assets from fiscal year 2009 to 2022. The group targets a near to medium term net leverage of below 2x. Management said it does not consider any material add-on or transformational acquisitions in the short to medium-term.

• History of restructurings due to aggressive expansion policy in the past: In 2024 Eroski had a debt pile of €2.6 billion driven by debt-funded expansion, largely attributable to its acquisition of Caprabo SA in 2007 for about €1.7 billion. In January 2015, Eroski extended its €2.6 billion loans and credit debt by four years to 2019 agreed by over 85% of lenders, following which the group has repaid a portion of the debt with asset disposals, though it has been struggling to close some sale agreements. The amount was then reduced to €1.531 billion in 2019, which was extended again to July 31, 2024.
  
  In FY’20 and FY’21 the company paid off €421 million to cover the amortizing portion of the bank debt partly through the sale of a 50% stake in Supratuc (the holding company of Caprabo and Cecosa Supermercados) to Czech company EP Corporate Group in Sept. 2021, as well as disposals of other assets. At the time the Caprabo asset owned through the Supratuc entity was deemed the group's most valuable asset. Afterwards a further €98 million was paid down with cash with €152 million to be written off following this transaction.
   
• Strong margins compared with non-discount retailer peers, though margins may decline: The group managed to expand its adjusted EBITDA pre-IFRS 16 margin to 5.8% for fiscal year 2022 and to 6.2% for LTM, from 4.4% for 2014, partly driven by the refocusing of its portfolio to core regions, inflation pass through to customers, and cost control measures. The group’s pre-IFRS EBITDA margin in fiscal year 2022 is above Tesco’s 5.2%, Casino’s 4.6% and Carrefour’s 4.3% margin, but below Lidl’s Spanish subsidiary’s 7.8% margin and Mercadona’s 6.1% margin. However, the EBITDA margin may decline from the current high level as inflation decelerates and consumers expect cheaper price levels, driving price competition in the market.
   
• Cash generation constrained by high interest expense, working capital movement: The group’s levered free cash flow margin has been constrained by working capital volatility, expansionary capex and in recent years by inflation-linked leases. While the group has historically done well on margin expansion, a 10% coupon on the debt will lead to break-even cash generation in the near term, if we take into account the €127 million of working capital outflow in the LTM period to July 2023. Reorg notes the group has €293 million of working capital facilities, which can be used to manage large working capital swings (see Financial Overview for more detail).

• Adequate liquidity position: Despite the absence of a revolving credit facility, the group has liquidity in excess of the company reported minimum cash balance of €70 million. Liquidity comprises €145 million of cash pro forma the transaction, complemented by €125 million of financial investments, which mainly include investments in Mondragon, Laboral Kutxa and other current financial assets that can be sold if necessary, according to the deal’s presentation. The group also has €293 million of working capital facilities, which were drawn by €151 million as of November, according to S&P Global Ratings.

• Strong reliance on 50:50 JVs, partner put option requires Eroski to buy out minority investors: Following the sale of a 50% stake in Supratuc to EP, if there is a disagreement between EP and Eroski, a casting vote may enable EP to exercise a put option that would require Eroski to repurchase its shares at market value within 12 months. However, according to the company, it is likely there would be enough interested parties such that the company would not have to purchase the shares itself. At the time, the Caprabo asset owned through the Supratuc entity was deemed the group's most valuable asset. The partially divested entities are of significance to the group as about 49% of the group’s revenue in the fiscal year 2022 was generated from Vegalsa and Supratruc, with minority shareholders owning 50% stake for each.

• Complicated cooperative structure restricts financial flexibility: Although 30% of employees are part of the cooperative, there could be former employees who maintain member status with all members having equal voting rights which could prove restrictive when making strategic decisions for the company. Moreover, the company must use its net surpluses from offsetting losses and paying taxes to cover a mandatory reserve fund (20% annually until reaching a 50% of share capital) and a contribution for cooperative education and promotion (10% annually), limiting surplus cash. In addition, non cooperative employees are protected by collective bargaining agreements signed with the unions in June 2023 with provisions that could affect the ability to restructure operations and facilities or terminate employee contracts.
  
  Further to this, the co-op structure prevents the attraction of top talent for management as the structure limits the pay of senior management to six times that of the average wage of its employees. This leads to senior management earning wages that are far below that of their competitors.

The covenants being proposed are more conservative than Reorg typically sees in the market, with below average day-1 capacities.

Our legal analysts have highlighted also the following key concerns associated with the issuance:
 

• Uncapped cost savings and synergies: uncapped cost savings and synergies are permitted from investments and operational changes with no time period for their realization specified. 46% of 2023 to date European high-yield bonds in Reorg’s Market Maker database permitted uncapped cost savings and synergies, but investors successfully pushed to have a cap on synergies as per our Covenants Pushback Tracker, including in Assemblin’s 2029s in 2023. The 18 “look forward” time horizon for synergies and cost savings anticipated from operational changes is not for realization, but for taking the actions that will result in such cost savings or synergies. Investors may wish to impose a cap of 25% of EBITDA, as would be consistent with other deals in the market that have capped cost savings and synergies add backs.
   
• No single-point of enforcement: No security will be provided over the shares of Eroski, the issuer. Looking at the organizational structure chart, share pledge enforcements will need to take place below the issuer, at each relevant subsidiary of the issuer whose shares secure the notes due 2029. We suspect that no security is provided over the shares of Eroski due to its cooperative structure, but investors should confirm this.
   
• The notes due 2029 could mature in 2027 rather than 2029: If the subordinated negotiable securities due Feb. 1, 2028 (OSEs) are not refinanced or repaid by July 31, 2027, the new notes will mature on July 31, 2027 instead of July 31, 2029.
   
• Bridge to Disposal Facility: Under the preliminary OM, the €35 million Bridge to Disposal Facility is excluded when calculating the opening ratios. But nothing in the preliminary OM states that such debt is excluded from the covenant calculations. Although the impact is limited as it increases the net leverages by 0.1x. Investors should clarify.
   
• Unclear amount of collateral dilutive debt at issue under the Confirming and Guarantee Facilities: At issue, the Confirming and Guarantee Facilities will be secured on pari passu basis with the new notes. However, it is unclear from the prelim. OM whether the €243 million debt under this facility is committed or outstanding. Investors should clarify.

Reorg’s covenant analysis on the new notes is available HERE.
 
Eroski was founded in 1969. It is a leading multi-format and omnichannel food retailer operating as a consumer cooperative company in Spain. A consumers' cooperative is an enterprise owned by consumers and managed democratically aimed at fulfilling the needs and aspirations of its members. As of July 31, 2023, 30% of employees were a part of the cooperative.

The group conducts its business through two main categories of operations – food and non-food, diversified businesses. The food business is presented to customers through supermarkets, operated in a multi-format approach, including supermarkets, hypermarkets, cash & carry stores, while the non-food, diversified business focuses on gas stations and sports equipment stores.

The group has 1,500 stores in Spain, of which 731 are Eroski-operated supermarkets, 615 are supermarkets operated as franchises, 36 are operated as hypermarkets and the remaining 17 are Eroski-operated cash and carrys. On the non-food side, the group runs 40 gas stations and 66 sports equipment stores.

Below is a breakdown of Eroski’s LTM revenue by format and geography, with Eroski-owned stores representing 64% and Northern Spain representing 40% followed by Galicia with 24%.
 

The group holds one of the top three leading market positions in terms of sales across their core regions. In the Basque country, Navarra and Balearic Islands the group holds the number one position. In Galicia and La Rioja the group holds the second and third market positions respectively. Its market shares are 37% in the Basque Country, 28% in Navarra, 21% in the Balearic Islands, 19% in Galicia. These core regions contribute to over 90% of its full year adjusted pre IFRS-16 EBITDA.

The group's pricing level is competitive compared with most peers for the basic basket of goods. The group says it carries a higher price point on less price sensitive goods, which drives higher margins.

The group sells private label goods, which account for 30% of food sales as well as globally recognised brands.

Eroski’s online channel was launched in 2000. The group has since launched a phone app and a “Capraboacasa” delivery service in the Barcelona metropolitan area. Online sales comprise 2% of the group's total sales in fiscal year 2022 ended Jan. 31, 2023 .

The groups main KPIs are sales to surface area and adjusted pre-IFRS EBITDA per store, which we can see below has increased from fiscal year 2019 to the LTM period to July 31, 2023.
 

EBITDA per store has increased compared to fiscal year 2019 and is now in line with the abnormally high levels experienced during the pandemic in fiscal year 2020.

 
Franchises

The group’s franchise stores complement the existing geographic reach of the Eroski-run store network, which operate in the core regions mentioned above.

The franchised stores have the benefit of meeting specific demands of the local market and creates brand awareness in smaller catchment areas with lower population densities that might not fit the investment profile of the main group.

Franchised stores must purchase 90% of their inventory from Eroski and have 10% freedom to purchase the remainder of their inventory from other suppliers, provided they are not Eroski competitors. This applies to all franchises except Aliprox.

Franchises pay a recurring royalty fee on their purchases. In the fiscal year 2022, franchisees purchased €503 million in inventory, comprising 10% of Eroskis annual revenues.

The adjusted EBITDA pre-IFRS 16 margin from franchised stores is typically higher than the corresponding margin from owned stores.

In the fiscal year 2022, franchised stores generated €41 million of the group’s adjusted EBITDA pre-IFRS 16, more than tripling the €13 million of EBITDA generated by franchises for the fiscal year ended Jan. 31, 2014.

Co-operative structure

Lenders have long been at odds with the cooperative structure of the group as reported by Reorg since 2018. A cooperative is when stakeholders such as employees have a meaningful say in the running of the business, this is not uncommon in Spain, however what is uncommon is the membership of consumers.

Cooperative members pay €11,000 to join the membership, and they can decide on how they distribute profit to the extent there is profit to be distributed. When members leave or retire they are able to request their initial down payment back but it is up to the vote of the general assembly to decide whether to repay it.

The consumer and employee groups interact with the board via the governing council which convenes at the general assembly. An overview of the governance structure is included below.
 
Source: Company website
 
Revenue

The group’s revenue grew at a CAGR of 1.9% from fiscal year 2020 ended Jan. 31, 2021 to LTM July 2023, and 2.8% from the fiscal year 2019 to LTM July 2023 period.

Revenue growth over the period has largely been driven by external factors. In the fiscal year 2021 ending Jan. 31, 2022, revenue fell 5.5% year over year as the group’s Covid-19 related tailwinds, in which consumers pivoted from restaurants to groceries, dropped off as vaccination programmes rolled out across Spain. In fiscal year 2022 ended Jan. 31, 2023 revenue increased 6.3% year over year driven by price inflation due to the ongoing conflict in Ukraine, which led to significant price increases in barley wheat and other grains used for making staple foods.

The first half of 2023 ended July 31 was a year of organic growth mainly due to an increase in consumer activity in response to the group's pricing policy, including discount promotions and price containment in response to food inflation of 9.89%.

Gross profit margin

The group's gross profit margin has been squeezed in recent years as a result of increased raw material costs passed onto them by suppliers for cereals like grain and wheat following the conflict in Ukraine. Generally the gross margin has remained in the 26% to 27% region, falling from 27.2% in fiscal year 2020 to 26.3% for the LTM period.

Pre-IFRS 16 Adjusted EBITDA

After the gross margin line, the group describes its cost base as largely fixed in the short to medium term. Its other costs generally increase periodically based on the size of the network of stores and the sensitivity of certain costs to inflation. Although the cost base is largely fixed, the group has a degree of control over marketing costs through the use of short term contracts. Despite declining gross profit margin on increased raw material costs discussed above, pre-IFRS 16 adjusted EBITDA margin improved to 6.2% for LTM from 5.7% in fiscal year 2021.

Historically, labor costs represented between 44% and 52% of the group’s cost structure. The group mentions it is able to agree salary reductions, where necessary, with cooperative workforce members who represent 30% of the workforce. However, it is subject to Spanish minimum wage laws. Additionally, agreements with trade unions and other labor force actors typically include limitations on its ability to reduce its workforce.

Certain expenses, such as rental and energy costs, are for the most part unhedged and the group is exposed to price fluctuations in this respect. Nevertheless, the general market consensus is that we are past the energy inflation peak, which should act as a tailwind for the group.

Energy costs are significant to Eroski as storage and stores need to be kept cold 24/7 as 38% of food revenue in fiscal year 2022 was derived from fresh food, combined with costs for lighting for stores.

The group's adjusted EBITDA pre-IFRS 16 has grown by a CAGR of 5.1% between fiscal year 2019 and LTM period with LTM margin of 6.2%, exceeding the fiscal year 2019 margin of 5.8%. The group has offset the effects of the macro environment on its cost base by executing a number of cost efficiency projects in the following areas: point of sale operations, improvements in productivity, platform efficiency, efficient supply and logistical efficiencies. Regarding energy use, the group has developed cold rooms, which are more energy efficient than fridges, and installed energy efficient LED lights throughout its store network to help mitigate energy costs.

Management stated that while efficiency projects have helped to maintain strong margins, it has also allowed the group to remain competitive as it provides leeway for it to aggressively price against competitors.
 

In the first half of 2023 the group’s adjusted EBITDA margin pre IFRS-16 was 10.2%, which was well in excess of the 5.8% reported in fiscal year 2018.

Working Capital

Below EBITDA is working capital which the group says is structurally negative, as customers pay up front and the supplies are paid on average 55 days afterwards, which is beneficial for the group.

The group had outflows from changes in working capital of €88.1 million for FY’21, €34.3 million for FY’22 and €127.3 million for the LTM period, largely driven by outflows related to trade and other payables. The company noted that the balances in recent years have been impacted by the ramp up in activity during the pandemic followed by normalization in FY’20 and FY’21 and the revaluation of inventory driven by inflation in FY’22, which has not been uncommon across inventory heavy industries.

The group made adjustments to changes in working capital which we have summarized in the table below. The average variation in working capital adjusted for supplier DPO financing, reverse factoring and float, which is cash to be imminently used in the working capital cycle, is around 0.2% of sales.

   
Capital Expenditure

Capital expenditure can be split into two main items
 

• Maintenance capex (1% of revenue on average) represents capital expenditures for the refurbishments required to enable the stores to operate and the substitution of the out of date equipment in the stores

• Expansion capex (1.5%) is discretionary in nature and represents capital expenditures required for the opening of new stores and remodeling of existing stores. The group stated that expansion investment had been constrained by previous capital structure.

The company does not disclose the breakdown of expansionary capex between store formats and new store openings. Based on trends, although the group said such capex is discretionary in nature, we consider it prudent to assume a similar level of expansion capex to be maintained going forward given the need to upgrade store formats to remain competitive.

 

The number of stores increased between fiscal year 2020 and fiscal year 2022, however, as of July 2023 the number of stores decreased by 119 units or 7% to 1,505 units, since the end of fiscal year 2022 as a result of disposals.

Leases

97% of the group's stores are leased. The group's lease payments averaged around 3% of revenue in the last four financial years; however, these rental expenses are linked to annual CPI which we believe may be the main driver behind growth in lease payments in the LTM, given the overall reduction in stores. The group has since carried out negotiations with landlords to limit rent increases to between 2.5% and 3.0%
 

Regarding the 3% of the real estate properties it operates with a book value of €287 million; of this amount, about €260 million real estate assets are viewed as non-core (including about €19 million of post reporting realized asset sales and a further about €35 million planned real estate asset sales). An estimated 10% of owned real estate is used by the group as shops. Between fiscal year 2009 and fiscal year 2022 the group has disposed of €1.5 billion of non-core assets.

Cash Flow Generation

The main driver behind cash flow volatility has been atypical working capital movements. We would estimate the group’s levered free cash flow generation margin to be around the 2% region. The group’s levered and unlevered free cash flow margins are below.
 

See below an overview of LFCF and ULFCF adjusted for the group’s adjusted working capital metrics and expansion capex.
 

We calculate that a cash EBITDA of €529.8 million, pro forma cash interest of €95.1 million, cash taxes of €13.9 million, working capital outflow of €127 million, capex of €110 million and €187 million of cash leases, which leads the group to around break-even cash flow. Positively, we note that the group has €293 million of working capital facilities which could be used to absorb the working capital outflows.

Cash interest has been calculated using 4% as three-month Euribor plus the upper end of the guided coupons for existing facilities and the new term loan A and price whispers of 10% on the existing notes.

The issuer’s historical financial performance is below.
 

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Full financials for Eroski on Fundamentals by Reorg are being added HERE.
 
While Eroski is new to the bond market, the group is not new to Reorg. We have been covering the credit since 2017 as the company has held talks and negotiated with its creditors, with traditional banks selling pieces of debt ahead of an upcoming maturity wall.

Following the financial restructuring in July 2019, Eroski, S. Coop extended the maturities of its €1.503 billion bank debt and working capital financing facilities to 2024. Guarantees of €28 million were also extended by the group to related and non-related parties, increasing the total nominal amount to €1.531 billion. The refinancing agreement divided the group’s debt into two tranches: €1.022 billion with a coupon of Euribor + 2.5%; and €509 million with a fixed rate of 0.5%.

The €509 million tranche includes €200 million accruing 0% interest attributable to the subsidiary Cecogoico SAU subject to a requirement to repay a portion of the loan due in December 2021, which was met.

Since then, the nominal amount was reduced to €703 million, which will be repaid with proceeds from this refinancing transaction. A summary table to bridge from initial nominal amount to latest amount to be refinanced is below:
 
To summarize, the €828 million reduction of the outstanding nominal amount of its bank debt includes €519 million from repayment with cash, as well as a €309 million debt writedown (including €152 million to be written off on or about the issue date of the new notes).