It’s getting tough for our over-indebted, junk-rated LBO queens.
As so many times, there’s a private equity angle to it: the cycle of LBOs, debts, and defaults.
Many retailers are over-indebted, junk-rated LBO queens, some dating from the LBO boom that ended so spectacularly in 2008: luxury chain Neiman Marcus, supermarket chain Albertsons, J. Crew Group, 99 Cents Only Stores, Bon-Ton Stores, jewelry and accessory retailer Claire Stores….
They’re now bogged down in the current brick-and-mortar retail quagmire. Strip away booming auto sales and soaring internet sales: the rest of retail is tough. And many of these retailers are trying to balance precariously above their heads the pile of debt thrown at them over the years by their private equity owners.
The vast majority of retailers are junk-rated, with the “B” category dominating the rating scale, according to S&P Capital IQ Global Credit’s retail report.
It was already tough last year: of the Standard & Poor’s rated US retailers, 11 defaulted – the most since crisis-year 2009. And for 2016, we already have this to look forward to: 24 S&P-rated retail and restaurant bond issues (which S&P lumps together) have plunged so much that they’re now trading at “distressed levels” and are included in the Standard & Poor’s Distress Ratio.
The ratio (more, including the chart here) is the proportion of junk-rated bonds with yields that exceed Treasury yields by at least 10 percentage points. This category of retailers and restaurants is now in third place in the Distress Ratio, behind the doom-and-gloom categories of “Energy” and “Metals, Mining, and Steel.”
So 2016 is going to be even tougher for retailers. And it might drag out. Thanks to refinancings at the tail end of the great credit bubble when everything was possible, and thanks to the still low interest rate environment, liquidity is “adequate” for many retailers for 2016. But the report sees a number of risks beyond liquidity this year, among them:
- “Consumers become even more cautious and hardwired to seek discounts.”
- Companies have only “limited success” in adapting to “shifting consumer preferences.”
- “Subpar economic growth in many markets.”
Department stores, specialty apparel stores, and specialty retail stores are in particularly hot water, according to the report: “Without a positive development in consumer behavior during the holiday season, we assume 2016 will continue to challenge companies’ ability to meet shifting consumer preferences for value.”
But that’s the rosy scenario for 2016. The report assumes that consumer spending will grow at “about 3.3%.” Even then:
[W]e don’t think small ticket retail will be as strong as this overall consumer spending forecast might imply. Sales may rise, but margins will depend on retailers’ inventory positions and cadence of promotional activity, which we think remains intense.
The 2015 holiday season and all of 2016 will pose more downside risk than upside for companies’ credit quality. We acknowledge the windfall from low gas prices has not benefited retailers much.
Stagnant wage growth and competition for “share of wallet” from health care, technology, and “experiences” will be a headwind in 2016.
Aggressive shifts in financial policies to return capital to shareholders by investment-grade issuers is a downside risk.
And this is how S&P credit analyst Robert Schulz summarized the issue to Bloomberg: “We expect more retail defaults in 2016 than 2015 and 2014.”
This time it’s different. Now, brick-and-mortar retailers have industry-specific issues, on top of whatever overall economic issues they may face in the US.
“What looks the same but costs three times less is where everyone’s going,” Patrick Dalton, CEO of Gordon Brothers Finance Co., an asset-based lender that works with retailers, told Bloomberg. Consumer spending for “stuff” is under pressure as folks like to spend more on “experiences,” such as dining out. And then there’s the internet….
“Amazon is crushing everybody,” Dalton said. The same Amazon which operates under a different set of market expectations than any other retailer. Unlike them, Amazon isn’t struggling with its debt, and it isn’t under pressure to maximize its profit, or even have any visible profits, as long as it shows revenue growth.
But that’s not the case for others. J. Crew, burdened by $2.1 billion of debt from its 2011 LBO by TPG and Leonard Green & Partners, saw its bonds fall to 25 cents on the dollar in December, according to Bloomberg. And the 8% notes of Bon-Ton Stores, which in November had blamed the “unseasonably warm weather” and “continued weakness in overall traffic trends” for its crummy results, last traded at around 33 cents on the dollar.
Now restructuring advisors are back in business. The industry has been starving on the sidelines for years during the Fed’s great credit bubble when nearly all companies, no matter how much they were in trouble, could borrow at ludicrously low interest rates and use the proceeds to service existing debt. But that game is now petering out.
Restructuring advisors are already making money hand over fist, advising energy companies on restructuring their debts and slashing their debt burden at the expense of stockholders and many classes of creditors, with or without a bankruptcy filing. These folks are now eyeing retailers.
And they have “already started circulating names of retailers proposing various debt-renegotiation plans as bond prices continue to drop,” according to Bloomberg. Steven Ruggiero, a credit analyst at RW Pressprich, put it this way: “It’s going to be a busy year of restructuring for retailers.”
And tough times for investors in those retailers!
The overall Distress Ratio for US corporate bonds is soaring, and globally, the corporate default rate is the highest since 2009. Things are coming to a head. Read… Global Corporate Debt is Coming Unglued
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