(Bloomberg) -- Investors are beginning to sniff an opportunity where the rating agencies see trouble — Chile’s Falabella SA.

Just days after the company, which owns malls, department stores and supermarkets, unveiled plans to reduce its debt load and return to profitability, Fitch Ratings and S&P Global Ratings both cut the company to junk last week. The bonds due 2032 dropped 2.53 cents on the dollar to 70.59 cents in the week. 

But with the notes now hovering just above record lows, investors are taking a more benevolent view of the retailer that racked up losses after investing heavily in e-commerce amid stiff competition and weak consumer spending. Plans to sell as much as $1 billion in assets may have left the rating agencies cold, but they impressed some bondholders.

“In the longer term, it’s a great story,” said Elizabeth Bakarich, an emerging markets corporate debt portfolio manager at AllianceBernstein, who noted there is not much in the corporate bond space in Chile that is high yield. “At these spreads we’re interested in the opportunity it creates.” 

Bakarich manages an emerging markets debt portfolio that includes Falabella bonds due in 2027. 

Debt Load

“We are working with a sense of urgency to strengthen our financial position,” Falabella said in a response to emailed questions. “We hope that our attempts to boost efficiency, combined with the normalization of the macro environment and the sale of assets, will enable us to recover investment grade as soon as possible.”

The company has seen its total debt to Ebitda increase steadily since 2021. The ratio now stands at 7.32, compared with 3.8 and 5.97 at local peers Cencosud SA and Parque Arauco SA, respectively.

Yet plans to unload assets, starting with a 66.6% stake in mall operator Mall Plaza Peru, should start to ease that debt burden next year. Falabella plans to sell the unit to another of its subsidiaries Mall Plaza.

“With the 10-year yields at almost 8% for Falabella, I consider it a good level to enter,” said Nicolas Morande, partner at wealth advisory firm Damon Capital.

Still, the bonds could get worse before they get better. The double downgrade means funds with only investment grade bonds will now have to sell. At the same time, both rating agencies kept the company outlook at negative, indicating more cuts are possible.

The bonds had priced in the downgrade, but not the negative outlook, said Josefina Valdivia, fixed income manager at Credicorp Capital. 

All the same, the downward pressure on the bonds may be muted as forced selling by investment grade funds might only impact 8.8% and 7.6% of the amount outstanding of the 2027 and 2032 notes, respectively, JPMorgan analyst Eugenia Cavalheiro wrote in a note to clients in September. JPMorgan said last week that no new analysis was available on the exposure to these funds.

Achilles Heel 

Bakarich says investors don’t think the company has a liquidity issue and doesn’t need to raise fresh capital. Its Achilles heel is communication. 

“The company has deleveraging plans, but they weren’t as specific as they needed to be in terms of those assets, what their timeline was and what their leverage targets were over the near term,” Bakarich said. “There’s definitely more that they could have done to inform the broader market.”

Credicorp’s Valdivia says Falabella also needs to make more structural, strategic changes, such as reducing capital expenditure. And if Mall Plaza has to issue debt to finance the purchase of Mall Plaza Peru, it won’t help delevarage Falabella as it has a controlling stake, she said.

If the businesses continues to deteriorate, there could be another downgrade, and recovering their investment grade would take a long time, Valdivia said. Their goal should be to get a “positive” outlook in the next six to 12 months. 

Uncertainty over who will succeed Gaston Bottazzini as CEO could also weigh on the bonds. Bottazzini resigned in September after the plunge into losses.  

The new management has “to give confidence,” Bakarich said. “A new CEO needs to inspire that.” 

At the same time, investors need to understand the company is cyclical and be patient to see results of the cost reductions, she said. 

“We believe their willingness to bring this back to investment grade is high,” Bakarich said. “We think their plan is credible and we think that they have the ability to execute on it.”

ECONOMIC CALENDAR:

All events in Santiago local time.

  • Chile
    • Nov. 29 9am: October Unemployment Rate
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  • International
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      • Nov. 27: New Home Sales
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      • Nov. 29: Federal Reserve Release Beige Book
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      • Nov. 30: November MNI Chicago PMI
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      • Nov. 29: November Manufacturing PMI
      • Nov. 30: Caixin China PMI Mfg
    • Europe
      • Nov. 28: October Eurozone M3 Money Supply
      • Nov. 29: October UK Mortgage Approvals
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      • Dec. 1: November HCOB Eurozone Manufacturing PMI

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--With assistance from Eduardo Thomson.

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