Competitive challenges are intensifying and the credit erosion among more challenged retail sectors and individual retailers is crystallizing rapidly as more issuers file for bankruptcy and miss payments, Moody’s Investors Service said in a report emailed to Retail Dive on Wednesday.
The competitive challenges weighing on earnings performance for bigger retailers like Amazon.com, Walmart Stores, Best Buy and Target will have potentially devastating ripple effects for smaller, more challenged retailers over the next several quarters, Moody’s noted in the report, “B2/B3 Issuers Gain Spotlight As Distressed Retail and Apparel Ranks Grow.”
Common characteristics of retail and apparel companies with lower credit ratings include stressed liquidity, weak quantitative credit profiles, challenged competitive positions, sponsor ownership and erratic management structure, Moody’s said. Liquidity is typically the driving force in its assessment of B2/B3 credit risk, and a key determinant in any drop into Caa/Ca territory, according to the report. “Risk becomes more acute when a company is facing a meaningful debt maturity,” Moody’s said.
Moody’s new report details how factors beyond the nitty gritty of quantitive credit profiles can worsen or mitigate ratings. The report highlights Toys “R” Us and BJ’s Wholesale whose market positions, size, and scale have afforded more flexibility and “lift” when it comes to the ratings. Conversely, there are companies with more solid quantitative profiles, but which Moody’s views as experiencing competitive pressures that “overwhelm” those metrics. The most recent retailer to file for Chapter 11 was Rue21 on May 15, and Gymboree missed its June 1 interest payment, Moody’s noted.
Moody’s describes Toys R Us as a “fallen angel,” whose initial downgrade in 2004 was a reflection of the fact that it, as Moody’s puts it, was no longer in control of its competitive destiny, while Walmart and Target were in the driver’s seat in the toy segment. During the holiday season in particular, those retailers forced Toys R Us to compete on price, which hurt margins.
But throughout “myriad refinancings" (including one in 2016 that Moody’s deemed a distressed exchange), and multiple CEO turnovers, Toys R Us managed to maintain market share, relevance and generally solid liquidity, accordion to the report. “This has been one of the key factors that has kept the rating from dropping … even when factoring in its serial debt maturities and a quantitative profile” that has sometimes seemed to warrant a lower grade, according to Moody’s. “Throughout, Toys has held onto its position as the year-round destination toy retailer. It has also held up fairly well against the cutthroat holiday promotional environment that is spurred by Walmart, Amazon and Target, all of which deeply discount toys to drive web and store traffic. It also has strong vendor relationships with Hasbro and Mattel, which we believe have a vested interest in supporting Toys with exclusive product and in some cases favorable vendor terms. We cannot envision either of these key vendors benefiting from a toy retail segment led by three mammoth retailers that view the toy category as a seasonal traffic driver.”
Turning to BJ’s, Moody’s says the wholesale membership-based retailer was saddled with some $2 billion in new debt from its leveraged buyout from private equity firms Leonard Green and CVC Capital Partners. In the aftermath of that sale, BJ’s metrics, (including debt and earnings before interest, tax, depreciation and amortization) weakened significantly, but Moody’s took into account the retailer’s franchise strength and competitive position. “BJ’s competitive position remains formidable, and its operating performance has generally held steady,” Moody’s said in the report, adding that its B3 rating is due to the impact on its quantitative credit profile of a highly aggressive sponsor-driven financial policy.”
More generally, Moody’s predicted that loan maturities will gather pace in coming months, with B2/B3 issuers facing a possible $1.1 billion in maturities in 2018, primarily for asset-based loan and revolver facilities. Issuers will be facing rising maturities at a time when maturity schedules are accelerating across industries and the default forecast for this sector is rising, Moody’s said.
While the 22 distressed retailers – (those with corporate family ratings of Caa/Ca) – make up just 15% of the 148 rated issuers in Moody’s industry group, that minority remains under pressure. The ranks of the distressed will therefore grow over the next 12 to 18 months, with more defaults expected in the months ahead, Moody’s warned.
“The majority of retailers remain fundamentally healthy,” Moody’s Lead Retail Analyst Charlie O’Shea said in a statement emailed to Retail Dive. “But as select groups of retailers continue to deteriorate – in particular department stores and specialty retailers – we believe the distressed ranks will keep growing, fueled in part by distinct vulnerabilities within the B2/B3 retail population.”