- Retail and apparel companies are facing a reckoning amid the coronavirus pandemic.
- J.Crew and Neiman Marcus filed for bankruptcy in the past week. According to media reports, JCPenney is set to follow suit.
- It’s only going to get worse, credit-ratings agency Moody’s warned. Its forecasted default rate for distressed retailers and apparel companies tripled from March to April.
- Even businesses considered essential like Rite Aid and Petco are struggling, thanks to hefty debt loads.
- “None of the companies in the discretionary retail and apparel sectors — no matter how strong — will emerge unscathed,” Moody’s analysts wrote in a recent report.
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The “retail apocalypse” that peaked in 2018 may have merely been a prelude to a far greater industry reckoning in 2020.
With the coronavirus pandemic shuttering department stores, apparel companies, and other shops deemed “nonessential” around the country, Wall Street is awash in distressed debt and restructuring work for struggling retailers.
Just in the past week, two industry giants have filed for bankruptcy. J.Crew, which is backed by TPG and Leonard Green & Partners, filed for Chapter 11 bankruptcy protection last Monday, and luxury retailer Neiman Marcus, owned by Ares Management and the Canada Pension Plan Investment Board, followed suit on Thursday.
JCPenney could be the next domino to fall. The company is preparing to close stores and file for bankruptcy as early as this week, Reuters reported on Friday, noting that no final decision had been reached.
But more pain is on the way, according to a report from credit ratings agency Moody’s, which has nearly tripled its default-rate projection for speculative-grade retailers and apparel companies. In early March, it had forecasted a 6% one-year default rate, but by mid-April that forecast jumped to more than 17% — on par with the peak of the retail upheaval in 2018.
Moody’s Investors Service
The number of distressed companies — with debt rated at “Caa1” or lower — has grown to 23 from 17 in mid-March, and the number “will only grow in coming months as weaker, smaller, stressed companies succumb to the pressures mounting from the industry’s broad, protracted shutdown and a subsequent slow recovery.”
“None of the companies in the discretionary retail and apparel sectors — no matter how strong — will emerge unscathed,” Moody’s analysts wrote. “It will be much worse for companies that went into the coronavirus crisis with weak balance sheets, challenged business models and weak liquidity profiles.”
The bulk of the distressed retail debt is concentrated in just nine companies. That list is topped by JCPenney and Neiman Marcus, but even some “essential” companies that have been able to keep their doors open are showing cracks.
Moody’s Financial Metrics
Drugstore Rite Aid, for instance, is open for business, but it’s struggling to compete with far larger rivals CVS Health and Walgreens Boots Alliance while servicing a nearly $6 billion debt load.
At $22 billion in revenue and nearly 2,500 locations, Rite Aid is no minnow. But competitors have gained scale through massive mergers, weakening Rite Aid’s market position. Walgreens earns more than $135 billion in revenue, while CVS generates more than $250 billion in sales.
Rite Aid’s own attempts to consolidate, most recently with grocery chain Albertsons in 2018, have fizzled.
Even as demand for pets has soared amid lockdown and stay-at-home orders, pet supply store Petco has struggled.
Its troubles predate Covid-19. Petco has nearly 1,500 stores and reaps $4.4 billion in revenue, but it’s been challenged by more nimble ecommerce players like Chewy.com and Amazon, as well as big-box outlets like Walmart and Target.
It’s also strapped with some $2.5 billion in debt stemming from the $4.6 billion acquisition in 2016 by CVC Capital and the Canadian Pension Plan Investment Board. Moody’s downgraded Petco to “Caa1” in April and expects the company’s capital structure to further deteriorate over the coming year, with debt levels exceeding 7-times EBITDA.
That’s the connective tissue between most of these firms: They gorged on debt, often at the behest of private-equity owners, and are struggling to stay afloat amid the pandemic.
The good news — if you’re a private-equity company or shareholder, at least — is that buyout shops have had success throwing their weight around to negotiate breaks, lifelines, and longer leashes for portfolio companies from their creditors.
“Private equity sponsors own most of the distressed retailers, which means many will try to amend credit agreements in ways that will be detrimental to creditors in order to avoid default,” Moody’s analysts wrote.
But with two high-profile bankruptcies underway and third one looming, and an end to the Covid-19 outbreak not yet on the horizon, this may be but a small comfort.
But even when stores reopen, they face a daunting recovery. Some retailers have started reopening in parts of the country, albeit with a slew of changes to protect employees and customers, such as capping customers, reducing hours, closing fitting rooms, installing plexiglass shields at registers, and quarantining returned items for at least 24 hours.
Aside from the necessary social distancing modifications, companies will be in a dogfight to regain traffic and unload inventory.
That means lots of promotions and sales that “will inevitably result in lower margins,” according to Moody’s.
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