Distressed bond issuers in the U.S. retail and apparel markets are nearing recession levels, tripling in the past six years, according to a report released by Moody’s Investors Service on Monday and emailed to Retail Dive.
The report found that 13.5% of Moody’s retail and apparel portfolio is distressed, compared to 16% during the Great Recession. Debt maturities are also headed toward record levels over the next five years, according to Moody's.
Retailers at risk — due to factors like stressed liquidity, weak quantitative credit profiles, challenged competitive positions, sponsor ownership and erratic management structure — include Claire’s, rue21, Sears, J Crew, Payless, Nine West, Gymboree, NYDJ Apparel, True Religion, Indra, Bon Ton department stores, David’s Bridal, TOMS Shoes, Tops, Velocity, Fairway, 99 Cents Only Stores, Charming Charlie and Evergreen Saver’s.
Moody’s Investors Service paints a stark picture of retailers under stress. Many are struggling under debt with unfavorable terms and challenged by developments that broadly and specifically challenge their operations. Store traffic declines, for example, have led many of these retailers to discount to the point of “irrationality,” while specific developments, like the bankruptcy of Korean ocean shipping company Hanjin, has made it difficult for fast-fashion retailers to swiftly get goods into stores, a key aspect of their supply chain.
“As they struggle to survive, distressed retailers can take more desperate measures, including highly promotional pricing that can border on irrational,” Moody’s Vice President Charlie O’Shea said in a statement emailed to Retail Dive. “This leaves stronger firms with the choice of either competing in a race to the bottom, or giving up sales in order to preserve margin.”
When retailers have liquidity issues, such troubles can swiftly lead to default. “Liquidity is the single most important factor,” according to the report. “If for some reason a company with a reasonable balance sheet, favorable market position, solid management and strategy were to face a debt maturity at an inopportune time in the financial markets, the situation could rapidly lead to default. This means companies need to proactively manage their maturities by refinancing well in advance of the actual date.”
While the report doesn’t name private equity or hedge fund firms as an issue, Moody’s does note that many retailers have turned to “financial sponsors” that provide highly leveraged funds.
“These deals almost always start with high leverage because the return calculus for the sponsors creates incentives for minimizing equity and maximizing debt,” according to the report. “Therefore, these companies are frequently challenged from the start, with weak credit metrics. Exacerbating this is the cadence of distributions to boost sponsor returns that typically follow, pushing the leverage envelope. When a highly leveraged company faces operating difficulties, Caa [low credit worthiness] is the usual result."
Retailers aren’t well suited to that kind of debt, experts have told Retail Dive, because their operations, especially in turnaround situations, are complex and require that merchandising, supply chain and other decisions be based on customer appeal as determined by retail personnel, rather than by financial gurus fixated on a shorter-time return.
The Limited Stores, Wet Seal, American Apparel have all shuttered stores amid bankruptcies in recent months; Wet Seal and American Apparel this year both filed for Chapter 11 protection for the second time in the last few years.
“Now private equity is there with billions in debt — and goodbye,” Howard Davidowitz, chairman of New York City-based retail consulting and investment banking firm Davidowitz & Associates, told Retail Dive earlier this year. “The first thing they do is borrow billions, and retailers can’t function that way because the business is too volatile and it’s too unpredictable. These poor apparel chains end up one way or another in the hands of private equity — and in the end, there’s no company, no stores, no employees, and the private equity made money. Congratulations. That’s how it works.”