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Retail distress deepens in US on drag from debt, web spending

Bloomberg logoBloomberg 2/2/2019 Katherine Doherty, Lauren Coleman-Lochner and Eliza Ronalds-Hannon
a sign on the side of a building: A dismantled sign stands outside a closed Sears store.© Reuters/Mike Segar A dismantled sign stands outside a closed Sears store.

The U.S. retail apocalypse is far from over.

While the collapse of storied merchants like Sears Holdings Corp. and Toys “R” Us Inc. has left stores shuttered across America, retailers still make up about a fifth of the universe of distressed borrowers. Consumer confidence is slumping.

On Friday, the head of the biggest mall owner in the U.S. cautioned that more retailer bankruptcies are coming. Economists are increasingly worried about a recession in the next year. And even relatively strong store chains like Macy’s Inc. and Kohl’s Corp. have warned that their results over the holiday shopping season were lackluster.

All this adds up to what Barry Bobrow and Lynn Whitmore at Wells Fargo Capital Finance see as a prolonged restructuring for the industry. It’s becoming increasingly difficult for retailers to delay their day of reckoning as they struggle with high debt and make necessary investments in online commerce.

“We’re heading more and more into a distressed market,” said Bobrow, managing director at Wells Fargo Capital Finance. Whitmore, managing director of retail finance, says retailers are laboring under debt levels that “just eclipses anything we saw in the recession.”

Default Rates Jump© Bloomberg Default Rates Jump

There are reasons to be hopeful about the retail outlook improving. Stores have improved their online sales, which could help operating income grow 5 percent to 6 percent this year, according to Moody’s Investors Service. The ratings firm raised its outlook on the industry to positive from stable in October, the first shift since July 2015.

Only about 4.9 percent of retail mortgages were overdue in January, down from more than 6 percent at the start of 2018, according to commercial mortgage bond data provider Trepp. And many of the biggest troubled retailers have already failed, said Sharon Bonelli of Fitch Group Inc.

Even so, there are still plenty of struggling merchants, and more will run into trouble if economic growth slows. David Simon, chief executive officer of Simon Property Group, the largest mall owner in the U.S., said on a conference call with investors on Friday that there are store chains that his company is “nervous” about, and that more bankruptcies are coming for retailers with high debt loads.

Default rates on the industry’s junk bonds have risen to 10.2 percent as of December, according to Fitch Ratings, more than double the 2017 figures, even if it’s down a bit from last year’s highest levels. Below are companies that have been flagged by analysts at Moody’s, S&P and Fitch as some of the most at risk of restructuring their debt or in some cases even filing for bankruptcy.

Neiman Marcus

The luxury retailer is saddled with nearly $5 billion of debt after its 2005 leveraged buyout and its 2013 sale to another set of private equity owners. The retailer has a $2.8 billion loan due next year, and has too much debt relative to its earnings, Moody’s analyst Christina Boni said in an interview. “If we had a magic wand and could get rid of their balance sheet issues, Neiman could move forward, focused on its core operations,” she said.

The retailer’s 8 percent notes due October 2021 trade at less than 50 cents on the dollar. Its first round of talks with its lenders ended last year in stalemate. The company is trying to talk to creditors again to cut its borrowings. A representative for the Dallas-based retailer said the company is confident it can come to a “mutually beneficial solution” with stakeholders. Neiman Marcus is in full compliance with debt agreements and has ample time to refinance its debt, the representative said.

Debt Due Date© Bloomberg Debt Due Date

PetSmart, Petco

Two of the largest pet supply stores continue to face competitive pressures from mega-retailers like Amazon.com Inc. and Walmart Inc. Both PetSmart and Petco have struggled to improve their online sales to help keep competitors at bay.

PetSmart acquired Chewy.com in 2017, taking on $2 billion of additional borrowings in the process. Unfortunately, PetSmart’s earnings are declining, making it harder to carry its debt, Moody’s analyst Mickey Chadha said.

A representative for PetSmart said, “The pet category continues to grow. While we continue to experience customer channel shift to online at PetSmart, we feel we are well positioned to capture and benefit from the growth in online through Chewy, and we are gaining market share on an aggregate basis.”

Petco has less debt, Chadha said, but it remains to be seen whether its own online platform can stay competitive, and both chains are at risk of losing exclusive products that draw shoppers.

A representative for Petco said the company rebuilt momentum last year and returned to growth. The company focused on improving nutrition in their pet food, expanded its grooming, training and veterinary services businesses, and achieved “double-digit growth” in e-commerce, the representative said.

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J.C. Penney

J.C. Penney has been through it all: boardroom battles, lawsuits, management turnover, activist battles -- and that was just in 2013. In the five years since, it has had three CEOs. The current head, Jill Soltau, took over in October and said the retailer is on track to generate free cash flow in the latest fiscal year and reduce its bloated inventory.

To do so, it may have to shutter a whole lot more outlets. The global retail think tank Coresight Research predicted one fifth of U.S. department stores -- about 1,150 -- will close between 2017 and 2023 no matter what they do. “The U.S. has far too many department stores,” said Deborah Weinswig, Coresight’s CEO. “In particular, it has far too many midmarket department stores that are competing in a similar, and highly challenged, space.”

A spokeswoman for J.C. Penney said that credit rating firms have maintained their highest liquidity rating for the retailer, and it has only $160 million of its more than $4 billion of debt coming due in the next four years.

Iconix Brand Group

Over the past four years, the owner of brands such as London Fog and Mossimo has endured a U.S. Securities and Exchange Commission accounting investigation, which isn’t over, and the departure of its founder as sales steadily slid. Now, Iconix has around $700 million of debt, including more than $100 million of busted convertible notes due 2023, which trade at about 44 cents on the dollar.

It’s even fighting with Jay-Z over his Rocawear brand, which it acquired in 2007. Eric Rosenthal, senior director of leveraged finance at Fitch Ratings, says the company is a “likely default” this year. Representatives for Iconix didn’t return requests for comment.

--With assistance from Brandon Kochkodin and Vivian Li.

To contact the reporters on this story: Katherine Doherty in New York at kdoherty23@bloomberg.net;Lauren Coleman-Lochner in New York at llochner@bloomberg.net;Eliza Ronalds-Hannon in New York at eronaldshann@bloomberg.net

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