Distressed retailers, already struggling to attract shoppers and service debt, may find it difficult to remain solvent due to the spread of the coronavirus and measures taken by governments and companies to contain it.
The response to the contagion, ranging from mass store closings and event cancellations to shifting many employees to work from home—all in tandem with fears of a recession—may prove insurmountable for a number of companies.
As Sarah Wyeth, lead retail analyst at rating agency S&P, put it: “Not that many retailers have the capacity to absorb a hit like this.”
That’s especially the case for weaker chains already beset by a lack of liquidity, unsustainable capital structures or execution problems. More specifically, retailers backed by private equity, which leverage companies with debt when they acquire them, will be challenged.
Sucharita Kodali, a retail analyst at research firm Forrester, said the future for some of these businesses seems near-impossible “unless they get some extensions or forgiveness on payments.”
Refinancing is about to get much harder
Disruption of the markets—the Dow Jones Industrial Average fell below 20,000 near mid-day trading today—is one of the contributors to a recession, according to Mickey Chadha, a senior credit analyst at Moody’s.
While there’s the psychological effect of a decline in the stock market, reverberations from the sell-off in equities spill over into debt, deeply damaging the health of companies, he said. That’s because businesses rely on the credit markets to function.
Distressed retailers in this type of environment will have difficulty getting refinanced at a rate they can afford, if they’re able to obtain financing at all, Chadha said. This pertains especially to speculative-grade issuers with a maturity in the next year or so, Wyeth concurred.
At the top of rating analysts’ watch lists are brands such as J.Crew, GNC and Lands’ End, all of which have upcoming maturities on their debt in early 2021 and could have difficulty refinancing. That’s if the volatility in equities continues to spill over into the capital markets, effectively closing access to them for troubled companies.
J.Crew is notable because it is currently attempting a refinancing tied to its IPO of Madewell, which was to take place in early March, according to David Silverman, a retail analyst at Fitch.
Proceeds from the IPO, which was postponed until the end of April, were to pay off a portion of the apparel brand’s term loan, with the remainder refinanced with new debt, he said.
Even under normal circumstances, pulling off an IPO and a refinancing would have been difficult for any mall-based apparel retailer, Silverman added.
Sellers of discretionary goods are at risk
It’s not just businesses in need of refinancing within the next 12 to 18 months that are in danger. Any retailer selling nonessential items with a shortage of cash flow and high debt load is at risk, including luxury retailer Neiman Marcus and department store JCPenney.
While retailers of consumer staples such as food and household cleaning products are expected to fare well, purveyors of discretionary goods are likely to see their sales decimated in the near-term as consumer confidence fades. An early sign of trouble: The University of Michigan’s consumer sentiment index fell by about 5% to 95.9 in early March from 101 in February.
“Discretionary spending could dramatically fall, at least temporarily,” Wyeth said.
Starbucks, for example, experienced a decline in comparable sales of 78% in China in February, with 80% of its stores closed at one point. While these numbers are specific to the food service sector, they give some sense of the potential extent of the damage.
J.Crew, GNC and Lands’ End, as well as Neiman Marcus and JCPenney, did not respond to a request for comment.
Retail was already facing challenges
The retail sector was already considered to be in a recession of its own before the coronavirus, which first appeared in Wuhan, China in December and declared an international public health concern by the World Health Organization in late January.
Indeed, in recent years the retail industry frequently had default rates (the percentage of total debt held by all retailers considered to be in default) in the high single digits, according to industry analysts. That’s because a number of retailers had difficulty evolving to meet the changes in consumer shopping behavior or had unsustainable debt loads, or both, among other factors.
Moody’s, Fitch and S&P’s list of companies pegged for possible default is extensive. That group includes, in addition to those named above, Petco, Serta Simmons, Ascena, Iconix, RiteAid, Guitar Center, Beverages & More (BevMo), Academy Sports + Outdoors, 99 Cents Only Stores, Fresh Market, Bluestem Brands, Belk and J.Jill.
These companies are already “on the bubble” of defaulting, Chadha said, noting that Moody’s has 17 companies tagged with distressed ratings.
He pointed out less-mentioned endangered businesses such as Outerstuff, a maker of children’s apparel under exclusive license with professional sports leagues, and Shoes For Crews, which produces slip-resistant footwear, as well as Boardriders, which owns surf brands Quiksilver and Billabong.
Retailers not included in the agency ratings are also experiencing liquidity difficulties such as Stage Stores, which is working with restructuring and financial advisers on a turnaround.
Small and medium-sized businesses are also at risk, as they don’t have easy access to capital, Wyeth pointed out. Building on that, Silverman said a number of independent businesses such as single-location restaurants, boutiques and exercise stores forced to close won’t be able to reopen.
The specter of recession
Economists and analysts are increasingly resigning themselves to the notion that there will be a recession, which is frequently defined as two consecutive quarters of negative GDP growth.
In fact, the University of California Los Angeles’ Anderson School of Management said on Monday the U.S. has now entered a recession, ending an expansion that began in July 2009. It expects the downturn to continue through September.
Eyeing the economic effects in China, industry observers said it’s more likely that retailers will experience at least some disruption for two to three months.
Trevor Bedford, a computational biologist at the Fred Hutchinson Cancer Research Center in Seattle, likened March 1 in Seattle to Jan. 1 in Wuhan in an interview with life sciences publication Stat News. It was in the context of attempting to convince health authorities to begin adopting social distancing measures.
It wasn’t until last week that companies such as Apple began reopening their stores in China after closing them for a month. Starbucks, another example, reopened its stores toward the end of February after closing more than 2,000 of them in late January.
Curtailment of commercial activities such as store closures is optimistically going to last until the end of this month, Wyeth said, but added that she doesn’t view that timetable as being realistic.
Silverman said one stark difference between the U.S. versus China and Italy is that the latter two appeared to lock down jurisdictions in an early and decisive manner. “Unless more is done very quickly, we may not see the curve flatten as quickly in terms of the virus spreading,” he said.
Apple notably will keep its stores outside of China closed for an indefinite period of time, a change from only a few days ago when the consumer electronics giant said retail locations would be shuttered until March 27.
Chadha compared the situation in the U.S. to a hurricane, only its impact is nationwide and lasts for a month instead of for a few days.
And like in the aftermath of a hurricane, expect pent-up consumer demand, said Andrea Weiss, CEO of retail consulting network The O Alliance. She said the initial days after a storm are usually a boom period for retailers, though second quarter sales will take a hit.
Sellers of consumer staples will fare better
Meanwhile, companies with plenty of cash on their balance sheets and a robust ecommerce presence are well-positioned, Wyeth said, particularly those that sell consumer staples such as food and household goods.
“The winners are grocers, Dollar General, Costco, Walmart, Target and Amazon,” Kodali said. “Just about everyone else is likely in trouble in some way.”
Walmart and Costco, for example, are currently achieving sales on a level typically associated with the holiday season, said Weiss. That’s even though they are shortening store hours for restocking and cleaning, while running short on supplies of some items such as toilet paper and hand sanitizer, she noted.
And these same retailers will also benefit because in addition to consumer staples, they sell apparel, electronics and home furnishings, among other items. Since competitors only selling discretionary items will likely be closed, the Walmarts of the world will in turn likely sell more of those kinds of goods in addition to essentials, Chadha said.
Generally in retailers’ favor is the fact that the cash on their balance sheets is at a peak level for the year, since they just emerged from the holiday shopping season, Silverman said. Likewise, there should be a greater available balance on their revolving lines of credit in the run-up to summer, before retailers begin to build up inventory for the fall.