A Memorable 2017, But Not in a Good Way; Why It Could Be Year of Retail Bankruptcies

By Kaya Yurieff

The list of troubled retailers seems to be getting longer by the day.

S&P Global Ratings recently downgraded four retailers: department store operator Macy’s (M) , luxury retailer Neiman Marcus, young-women’s fashion chain Charlotte Russe and thrift store operator Evergreen AcqCo1.

Macy’s was cut to BBB- from BBB last week, which is one level above junk bonds. The ratings change comes after the company reported weak fourth-quarter results, partially due to soft holiday sales.

“The downgrade reflects our view of the company’s weakened operating performance and competitive standing given the ongoing industry challenges, such as sustained low-customer traffic, increased price transparency and unrelenting competition from online, fast-fashion and off-price retailers,” credit analyst Helena Song said.

Fast fashion, from retailers such as H&MTopshop and Zara, has disrupted the historical supply chain model as it emphasizes getting new trends out into the market quickly and cheaply.

“Fast-fashion retailers have thus been able to flood the market with new, inexpensive styles and have been able to react quicker to changes in consumer preferences,” Credit Suisse analysts said in a recent note.

“Zara is the star,” said Cori Lopez-Castro, partner at KozyakTropin& Throckmorton. The retailer is able to change its merchandise very quickly and customers keep coming back to the store because they know they’ll see something new. “No one is going into Macy’s to see what’s new.”

Off-price retailers have also become more popular as consumers seek bargains and forego department stores and malls.

Standard & Poor’s also downgraded department store Neiman Marcus to CCC+ from B- with a negative outlook this month. “The company’s capital structure is unsustainable over the long term. Trends such as weak mall traffic, highly promotional retail apparel environment and cautious consumer spending continue to weigh heavily on Neiman Marcus’ operating performance and EBITDA,” Song said.

Mall-based Charlotte Russe is also struggling. S&P lowered Charlotte Russe’s rating to CCC+ from B- with a negative outlook earlier this month. “The company’s suppressed debt trading prices and lack of prospects for a strong, sustained rebound could lead the company to pursue a potential debt restructuring,” said credit analyst Andrew Bove. “The apparel industry will only be more challenged over the next 12 months to 24 months.”

Teen retailers have especially struggled as evidenced by a string of Chapter 11 bankruptcy protection filings from companies such as American ApparelAeropostaleWetsealQuicksilver and PacSun.

“Kids moved away from those brands. It wasn’t popular on social media,” Lopez-Castro said, adding that the aforementioned companies also didn’t have a strong e-commerce presence.

The teen market is extremely competitive, highly cyclical and very trend driven. “If you lose your touch, your shoppers can desert you instantaneously,” said Stephen Selbst, the chair of the bankruptcy group at Herrick Feinstein.

Weakness in the retail sector is also being caused by stagnant consumer incomes, changing consumption patterns and the growth of e-commerce, according to Selbst.

The core shopper of big department stores such as Macy’s and J.C. Penney (JCP) are middle class women and middle class incomes have been stagnant for a generation, he said.

Clothing purchases made up between 5% and 6% of consumer expenditure a generation ago vs. only 3.5% before the Great Recession. That decline is continuing, according to data from the Bureau of Labor Statistics, which showed that aggregate household spending on clothing has dropped almost 10% since 2005.

“There aren’t more dollars to go around,” Selbst said, but noted that the upper strata of the American consumer population is not being squeezed.

While retailers in the past have blamed sluggish results on a bad holiday season or unfavorable weather, he believes they are missing the bigger picture. “Consumption patterns are changing,” Selbst said.

The rise of Amazon.com (AMZN) and Walmart’s (WMT) Jet.com have accelerated the shift to shopping online. “The whole shopping experience has been radically changed,” he said.

As for the outlook of this year? Said Lopez-Castro, “2017 will be the year of retail bankruptcies.”

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Javier Lopez

Partner at KozyakTropin& Throckmorton

EDUCATION:  Harvard University (Cambridge, MA)

Javier A. Lopez has been named a recipient of the Hispanic National Bar Association’s Top Lawyers Under 40 award. At the firm, he focuses his practice on complex commercial litigation.

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Retail industry is expected to replace oil and gas as 2017’s distressed sector

Problems facing retailers include too many stores, declining mall traffic and the cost of keeping up with the competition

By: Tonya Garcia

Move over oil and gas.

The retail sector is set to replace the troubled energy sector as the most distressed of 2017, according to ratings agencies, lawyers and analysts, beaten down by the strain of competition from juggernaut Amazon.com Inc. AMZN, -0.03%  and a range of other issues.

The sector’s future is looking increasingly gloomy, with the cost of digital investments, trimming excessive store locations and lagging revenue amid declining traffic setting the stage for a spate of bankruptcies and restructurings in 2017 and 2018, experts say. The sector is grappling with changing consumer behavior and shrinking discretionary spending as consumers are faced with higher prices for everything from rent to prescriptions to gasoline.

Fitch Ratings’ “Bonds of Concern” list is filled with retailers, and the agency is expecting the default rate for the sector to jump to 9% in 2017 from 1% over the last 12 months. The retail sector had $38.9 billion in outstanding debt as of December. Research firm CreditSights has an underperform rating on the sector’s bonds.

Charlie O’Shea, Moody’s lead retail analyst, said his firm has 19 retail and apparel companies with a Caa credit rating or below, “the highest amount of highly distressed retail and apparel names since the recession.” That places them at least seven notches into speculative, or “junk” status, making them a high credit risk.

S&P Global Ratings, meanwhile, said the majority of outlooks across retail and restaurants are stable, but the ratings trends are negative.

“Shifting consumer preferences, and patches of global economic and policy uncertainty are contributing to the increasingly negative outlook bias,” the agency said this week.

In 2016, the energy sector was hammered by defaults, distressed exchanges and bankruptcies, although the recent recovery in the oil price to back above $50 a barrel has raised hopes the worst is over.

But the issues facing the retail industry threaten to overwhelm companies that don’t have the liquidity to adjust to the changing landscape. Despite positive January results, the hurdles facing the sector are adding up, but sales are not and it’s already taking a toll.

Eastern Outfitters, whose chains include Eastern Mountain Sports and Bob’s Stores, filed for chapter 11 protection last week, and The Limited filed last month, causing the company to close all its stores.

Other companies that have filed for chapter 11 or completely liquidated in the past year include Wet Seal, American Apparel, Aeropostale Inc. AROPQ, +3.18%  and Sports Authority.

Macy’s Inc. M, +0.03% Gap Inc. GPS, +0.79% Sears Holding Corp. SHLD, +6.76% and Guess Inc. GES, -0.88%  are among the retailers that have announced store closures in recent months. Macy’s and Sears are often anchor stores that are meant to drive traffic to malls, and specialty stores like Gap depend on the boost. Traffic declines are bad for them, mall operators, the restaurants and food courts housed in those malls, and other groups that depend on the mall ecosystem.

“What’s different about 2017 is we’re clearly seeing significant disruption from the rapid movement to online,” said Steve Barr, PwC’s consumer markets leader. He believes 2017 will be a “tipping point” and expects more bankruptcies heading into 2018.

“So at a time when they have significant debt loads, declines in traffic, they’re over-stored and e-commerce is still in investment mode, it presents a challenging profile,” said Barr.

Many of the companies facing trouble are apparel retailers, raising an issue unique to this area: relevance.

“Putting aside metrics like debts and cash, it seems harder to put your arms around it,” said Corali Lopez-Castro, partner at KozyakTropin& Throckmorton. “Trying to keep up with what’s next, then how do you get it into stores, then consumers don’t think you’re cool. How do you give your brand the cool factor?”

The question of how to get merchandise into stores only has one answer: quickly. Fast-fashion, like e-commerce, has changed the way retailers sell and present merchandise. Lopez-Castro highlighted the swift inventory turnover at Zara, an Inditex ITX, +0.19%  company.

“That’s why the consumer comes back,” she said. “They go back to the store knowing that they’ll see something new.”

Prolonged challenges can weigh on liquidity.

“A lot of retailers can survive one bad year,” said Philip Emma, senior analyst at Debtwire, a news and research firm focused on fixed-income markets. “But it becomes a problem when you string together a number of bad years.”

The 2015 holiday season, with its unusually warm weather and heavy promotions, hurt many retailers as shoppers were reluctant to buy warm winter clothing during a warm spell. The weather was more seasonal for the 2016 holidays, but the discounting persisted. Add competition and, in apparel, a lack of fresh trends, and there’s another holiday season that falls short.

“For certain retailers, if the business model isn’t sustainable, an initial debt cut might not be enough to get them through,” said Joshua Friedman, legal analyst at Debtwire. While he was reluctant to say that retail would follow in the energy sector’s path to bankruptcies, it’s “not hard to see distressed retail going into the restructuring field.”

The calendar isn’t helping either with Easter, an important holiday after the lull of the first quarter, pushed back this year. “Retailers have to get the goods in and pay for them and then there will be a lag time that will hurt their cash flow and further exacerbate the issues,” said Chuck Tatelbaum, senior attorney in the bankruptcy and creditors’ rights department at the Tripp Scott law firm.

As if that weren’t enough, there’s also political uncertainty, the specter of rising interest rates, and the task of trying to keep up, which all requires cash.

“Do you have the runway to make this change?” asks Moody’s O’Shea, who looks to Wal-Mart Stores Inc. WMT, -0.03% and all of the money it has spent to transform its business, from the multibillion-dollar purchase of Jet.com to price investments.

“It’s expensive,” he said. “The problem for many of these retailers is do they have the financial flexibility to cross the river and get to the other side?”

On Tuesday, Warren Buffett’s Berkshire Hathaway Inc. BRK.B, -0.05%  disclosed that it had slashed its stake in Wal-Mart in the fourth quarter to 1.39 million shares from 12.97 million.

The latest challenge facing the sector is a doozy: President Donald Trump and his administration are proposing introducing a border-adjusted tax, which would tax imported goods, possibly at a rate of 20%, and subsidize exports through rebates. Trump has called out many companies, particularly car makers, for producing in countries including Mexico and then shipping their products back into the U.S., arguing they should be taxed for behavior that is keeping well-paid jobs out of the country.

Retailers are major importers and apparel retailers import about 98% of their products. No surprise then, that a group of retail CEOs, including from Target Corp.TGT, +0.08% Best Buy Inc. BBY, +1.39% Gap Inc. and AutoZone Inc. AZO, +0.50% are in Washington, D.C.today, to meet with congressional leaders and President Trump to make their case against a border tax.

“Given that retail is the largest private sector American employer, retailers support sound policies that spur economic growth and job creation,” said Brian Dodge, senior executive vice president of public affairs at the Retail Industry Leaders Association.

The SPDR S&P Retail exchange-traded fund XRT, -0.05%  has gained 12% in the last 12 months, underperforming the S&P 500 SPX, +0.50%  , which has gained 25%.

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