Retailers have a hidden danger beyond falling sales
Even by 2022 standards, it’s been a tough year for retail. Today, debt is rising for the group, and while that’s still not a big worry for most players, it could be one more blow to a sector that’s struggling to attract investors.
While the S&P 500 is down 24% year-to-date, retail has been hit even harder, with the
SPDR S&P Retail
listed index fund (XRT) in free fall of 36% since the beginning of the year. This is due to a number of factors, from high inflation dampening consumer spending to poor inventory management decisions and recession fears.
Given these headwinds, debt may not be the primary concern for investors, but it is increasingly discussed only during pandemic boom times, especially as rising interest rates increases the cost of borrowing in all areas.
On Wednesday, reports circulated that
Bed bath and beyond
(BBBY) creditors were seeking to reach an agreement with the struggling home goods retailer over its debt maturing in 2024. Today Macellum Advisors struck again at
(KSS) on the composition of its board of directors; Previously, the activist investor criticized the department store’s balance sheet strategy, arguing that its own plan to monetize its real estate was a “far superior structure to any potential debt financing”. [
] could continue this would only serve to leverage the balance sheet and lower the valuation.
The good news is that situations like Bed Bath are in the minority. “Even retailers who are struggling right now or who are seeing a bigger contraction in revenue or earnings before interest, taxes, depreciation and amortization – many of them don’t have real liquidity or debt maturities coming over the next year or so, that would be of particular concern,” said David Silverman, senior director at Fitch Ratings.
This is largely thanks to the pandemic. In a sort of economic Darwinism, Covid-19 has accelerated the demise of many of retail’s weaker players – think of the rapid succession of bankruptcies in 2020, starting with J.Crew – while the rapid rebound in spending from consumption has strengthened the position of many remaining players companies. “It basically eliminated a lot of the restructuring that we expected over the next couple of years,” he said.
Many, but maybe not all. With Bed Bath, Silverman notes that Fitch is keeping a close eye on
(CVNA), a “classic startup, high-growth, money-losing retailer that constantly needs sources of cash to support its operations,” even as sales appear to be moderating below expectations.
Overall, credit worries are not a major overhang for the majority of retailers today, even as interest rates rise. Still, it looks like balance sheet improvements could be another pandemic benefit that retailers are missing out on.
Analysis of specialty retailers by BMO capital markets analyst Simeon Siegel shows declining cash levels over the past year, weighed down by factors ranging from excess inventory supply to strong shareholder returns .
“After a broad improvement, net leverage deteriorated, returning to above pre-pandemic levels,” he notes. “And while the number of companies with gross debt still lower than before the pandemic has improved, the broader rise in debt and cash flow challenges will remain a focal point until that the underlying trends turn positive.”
Inventory is probably the star there: Whether companies use steep discounts to clear merchandise or pay to stock it for the future, it’s dampened profits for many retailers.
Unfortunately, like him and Barrons have already noted – the strategic use of sales seems to be another lesson that retailers hoped they had learned in recent years, but turned out to be wrong. More recently, Siegel has pointed out
(NKE) disappointing strategy of selling more products but making less profit.
‘ (NWL) CEO once said Barrons that he understood that no discount would bring back some customers the company had gained during the pandemic given the discretionary nature of some purchases – a distinction lost on others.
This is also true for certain essential products, says Silverman: “You discount products when you need to generate excitement. Nobody will ever buy a carburetor just because you put it up for sale… Not only are you not going to generate additional volume, but you are giving a margin to people who would have bought it at full price anyway.
The good news is that once retailers run out of excess inventory, it should put more money back in their pockets. The bad news is that we’re probably not there yet, even if interest rates keep rising.
Write to Teresa Rivas at [email protected]