Asda - Reduction in Adjustments - Model Update

All,

Please find our updated analysis here.

Note: Beta testers can check Rekeep on the Asda portal here.

Building on our work on Morrisons, it is natural to look at the Asda capital structure. Having not followed the credit closely for some time, it took us a while to reconcile the current leverage and, more importantly, establish what we consider to be the appropriate EBITDA for the business. In essence, this is the key credit question: how much of the high level of exceptional and separation-related costs incurred over recent quarters will unwind, and how much of that unwind will ultimately translate into recurring EBITDA and cash flow.

Investment Considerations

  • We are not taking an active position in Asda. Our base case is for Actual EBITDA to improve over the coming quarters as separation costs roll off and trading recovers, but there remains meaningful execution risk. At 8–9% yields, we believe the bonds provide limited compensation for this risk and place too much reliance on further Sale and Leaseback transactions being available if required.

  • From current levels, we see limited upside for the bonds. Our base case assumes EBITDA recovery and a return to positive FCF in FY28, but this is already reflected to a large extent in current pricing. With leverage remaining elevated and the recovery dependent on execution, we see greater scope for the bonds to trade sideways than materially tighter from here.

  • The key issue is the appropriate EBITDA base. LTM Adjusted EBITDA has fallen from £1.17bn at the end of 2021 to £712m at Q2 2026. We would use c.£700–750m as the current starting point, with upside dependent on demonstrating that the recovery comes through in recurring earnings and cash flow rather than pro forma adjustments.

  • The principal downside risk is renewed pressure on trading. We do not expect a full-scale UK grocery price war, but further price competition or renewed availability issues could push the bonds down 5–6 points into the low 90s. Continued operational improvement should provide support at these levels given the stability of the underlying business and substantial property backing.

Current Trading

  • Asda’s Q2 results were mixed, with the pace of sales decline continuing to improve but EBITDA remaining under pressure. Ex-fuel revenue fell 2.3% on an Easter-adjusted basis and LFL sales declined 2.3%, while adjusted EBITDA fell 9.2% to £202m and margins contracted by 31bps to 3.1%.

  • The more important development was the improvement in the underlying trajectory. Market share was stable at 11.5%, food LFL declined 1.9%, and availability remained above 95%. Q3 trading subsequently turned positive, with ex-fuel LFL sales up 0.2% and food LFL up 0.7% in the seven weeks to 18 August.

  • Management continues to invest in price and the customer proposition, with more than 400 new products, upgraded fresh and frozen ranges and further expansion of Rewards. Asda has also retained its strong price positioning, although the key question for creditors is whether this investment ultimately generates sufficient volume growth to rebuild margins.

  • Liquidity remains the principal credit support. Q2 free operating cash flow was £322m, helping reduce net debt to c.£3.2bn, although a significant contribution came from working capital and should not be treated as fully recurring. The balance sheet therefore provides a meaningful runway for the turnaround while EBITDA remains depressed.

EBITDA Adjustments

  • The difference between reported and Adjusted EBITDA has historically reflected restructuring, Project Future, advisor and integration costs, acquisition costs, separation costs and other exceptional items. At Q2 2026, reported EBITDA was £234m versus Adjusted EBITDA of £202m, with £32m of adjustments.

  • Project Future has been the largest recurring adjustment in recent periods, with costs of £61m in Q2 2025, £81m in Q3 and £70m in Q4. Q2 2026 also included £23m of TSA and separation costs. These costs should decline as the Walmart separation is completed.

  • The more important issue for creditors is the pro forma EBITDA reconciliation. Asda has historically added back identified cost savings, synergies and annualised benefits, creating a material difference between Adjusted and Pro Forma Adjusted EBITDA. At Q2 2026, this difference was relatively small at £24m (£712m versus £736m), but it exceeded £150m at points during 2023–24.

  • We therefore view the reported LTM Adjusted EBITDA of £712m as the more useful reference point for current leverage. Pro forma adjustments should be treated cautiously until they are clearly recurring and supported by realised cash savings.

  • This distinction is particularly important given the deterioration in EBITDA over the past two years. The business now needs to demonstrate that EBITDA can recover through better trading and margins, rather than relying on an increasing number of adjustments to bridge the gap.

Happy to discuss. 

Tomas

E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk

Tomás MannionASDA