Millions made on Dixons Retail CDS in less than a week

See the pdf version of the report here……or continue reading below……

Credit market obervers last week would have noticed that Dixons Retail CDS was a very volatile name having soared past 1000 bps intraday last week*. What they may not have noticed is perhaps over $30 million in ‘easy’ profits made from over $700 million in credit default swap trades that occurred during the week of March 25, 2011 – a full 5 days before it made an important announcement regarding the upcoming year.

The retailer, whose stock is 11% held by Schroders, released a trading statement last week with a profit warning that contained a rather pessimistic view on the short-term outlook for the company saying,

trading conditions were expected to remain difficult through the first half of the year, with consumer sentiment improving as we moved towards Christmas 2011.  However, with consumer confidence even weaker than expected like for like sales in the 11 weeks to 26 March 2011 are down 11% in the UK & Ireland.  In this more challenging trading environment the business has focused on cash gross profits and has held gross margins flat year on year.  While this a relatively quiet period for the Group, management now expect that operating profit in the UK & Ireland division for the current financial year to 30 April 2011 will be approximately £70 million.

Analysts, naturally are now looking to peers to see if this is likely to be a broad issue, particularly in UK retail, or more specific to Dixons. British retailers like J Sainsbury and Next previously warned investors of the negative effect that consumer sentiment could have on sales, though in the case of Next the company actually reported a rise in profits. Marks and Spencer reports this week too.

Dixons Retail stock fell 3.06p, from 16.75p to 13.69p and continued to drop in subsequent trading sessions, and has fallen 61 per cent in the last year (until the announcement) giving it an overall market capitalisation of £453 million. It was just downgraded by UBS and the price had fallen below 12p.

Dixons Retail CDS, which formerly used to trade under the name DSG International soared on the news from the mid-700 bps range to the mid-900 bps range where it currently sits at.

February 2011 Trading

Between the weeks of February 18, 2011 and February 25, 2011, weekly activity fell from $347 million (41 trades) to $175 million (28 trades). According to a recent study completed by the DTCC last month, Dixons Retail CDS trading only averages 33 trades worth $222 million (£138 million) per week so the absolute levels of activity don’t appear to be out of the ordinary. However, what was more striking was the impact those trades had on the company’s net notional and gross notional values outstanding between that time. Net notional value increased almost 25% from $764 million to $952 million (see Figure 5) while gross notional value increased almost 5% from $23.6 billion to $24.7 billion (see Figure 4). By number of contracts outstanding, Dixons Retail CDS contracts rose from 3,861 to 4,057 – a 5% rise. By all three measures, the percentage increase in Dixons Retail CDS was one of the highest gainers of allsingle-name CDS during that week in question (see Figures 6-8).

[SIDE NOTE: The only other name that arguably saw more investor “interest” that week was the Italian energy giant, Eni SpA which, unlike Dixons Retail, also showed up as the 15th most traded name on the weekly active list for that week as calculated by CreditLime’s weekly update.]

March 2011 Trading

Then during the week ended March 25, 2011 (remember that is exactly 5 days prior to Dixon Retail’s public announcement), weekly CDS activity in the name appears to have soared to a record 139 contracts totalling $724 million in gross notional from the previous week where trading had been right in line with historical averages (32 contracts totalling $236 for the week ended March 18, 2011). That last full week of March’s activity was over 3 times the average weekly gross notional and 4 times the average weekly contracts traded – all before any equity investor was aware of Dixon’s impending investor warning on March 30, 2011.

Based on the jump in Dixon’s CDS price that occurred last week, an additional millions in paper profits have been made on those $724 million in trades that occurred, plus an undetermined amount that may have taken place in the first half of last week.

The activity for the week ended April 1, 2011, which covers the period including the public announcement (March 30) will be updated by the DTCC later today – but until then last week’s activity is still available on DTCC’s public website for everyone to look up and verify on their own if they would like.

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*Dixons Retail (DSG International), has long been a high premium name and this is not the first time its spread has reached 4-digits.  This FT report from 2008 illustrates back then that the

cost of insuring €10m of DSG bonds against default over a period of five years was an up-front payment of €3.3m and then annual payments of €500,000.

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