Number of distressed U.S. retailers at highest level since Great Recession
The number of U.S. retailers ranked at the most-distressed level of the credit-rating spectrum has more than tripled since the Great Recession of 2008-2009 and is heading toward record levels in the next five years, Moody’s Investors Service said Monday.
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The rating agency is the latest to weigh in on the state of the sector, and has 19 names in its retail and apparel portfolio, 14% of which are now trading at Caa/Ca. That’s deep into speculative, or “junk,” territory. It’s also a percentage close to the 16% considered distressed during the 2008/2009 period, said a Moody’s report led by retail analyst Charles O’Shea. The rise is part of a wider trend affecting sectors across Moody’s coverage that has retail replacing oil and gas as the most-troubled industry.
Retailers are in the midst of a secular shift to online sales led by juggernaut Amazon.com Inc. AMZN, +0.28% and that’s forcing many of them to spend heavily on their e-commerce operations. At the same time, mall traffic has slowed dramatically as consumer behavior changes, forcing many to discount heavily, hurting profit margins.
The 19 issuers on Moody’s list have more than $3.7 billion of debt maturing in the next five years, with about 30% of that total coming due by the end of 2018. The number is even higher when private credit is included.
“While credit markets continue to provide ready access for companies spanning the rating spectrum—allowing many to proactively refinance debt and bolster balance sheets—that could change abruptly if market conditions or investor sentiment shift,” said O’Shea.
The increase in distressed retailers comes after a long period of low interest rates, during which sponsor activity speeded up to meet investor appetite for yield. Each leveraged buyout cycle tends to produce a new pool of B2/B3 companies, a number of which inevitably get downgraded to Caa, said O’Shea. That was the case for Claire’s Stores Inc., J. Crew Group parent Chinos Intermediate Holdings A Inc., Tops Holding II Corp., and Rue 21 Inc., all of which now have weak credit metrics after taking on high levels of leverage to fund buyouts.
LBOs almost always start life with high leverage, because sponsors are incentivized to minimize equity and maximize debt in each deal to ensure their own returns.
“These companies are frequently challenged from the start, with weak credit metrics,” said O’Shea. “Exacerbating this is the cadence of distributions to boost sponsor returns that typically follow, pushing the leverage envelope. When a highly leveraged company faces operating difficulties, Caa is the usual result.”
That makes companies more vulnerable to default if credit markets tighten, as they tend to tap external sources of uncommitted capital to fund maturities. Moody’s is expecting the overall speculative-grade default rate to fall to 3.5% in January 2017 from 5.8% last January.
It did not provide a default rate forecast for retailers alone. But Fitch Ratings said recently it expects the default rate for the sector to spike to 9% in 2017 from its current 1% trailing 12-months level.
S&P Global Ratings, meanwhile, said the majority of outlooks across retail and restaurants are stable but the ratings trends are negative.
“Shifting consumer preferences and patches of global economic and policy uncertainty are contributing to the increasingly negative outlook bias,” the agency said in a recent report.
The main factors causing downgrades are stressed liquidity, weak credit profiles, challenged competitive positions, sponsor ownership and erratic management structures, said Moody’s. Anytime there is a sudden change in the C-suite, credit risk rises and the rise will be exacerbated if there is no clear successor in sight.
Wal-Mart Stores Inc. WMT, -0.90% and Costco Wholesale Corp. COST, +0.03% two of Moody’s highest rated retailers, have changed CEOs in the past few years without any bumps because of succession planning, said O’Shea.
A bigger pool of low-rated retailers also poses challenges for their stronger competitors, he said.
“As they struggle to survive, distressed retailers can take more desperate measures, including highly promotional pricing that can border on irrational. This leaves stronger firms with the choice of either competing in a race to the bottom, or giving up sales in order to preserve margin.”
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Other retailers on Moody’s list include Sears Holding Corp. SHLD, +3.88% Bon-Ton Stores Inc. BONT, -1.60% 99 Cents Only Stores Inc., Nine West Holdings Inc., True Religion Apparel Inc. and Fairway Group Holdings Corp.
The SPDR S&P Retail exchange-traded fund is up a paltry 1.6% in the last 12 months, while the S&P 500 SPX, +0.10% has gained 22%.
The number of U.S. retailers ranked at the most-distressed level of the credit-rating spectrum has more than tripled since the Great Recession of 2008-2009 and is heading toward record levels in the next five years, Moody’s Investors Service said Monday.
Don’t miss: Nordstrom says Trump’s tweets after Ivanka’s collections were dropped didn’t hurt results
The rating agency is the latest to weigh in on the state of the sector, and has 19 names in its retail and apparel portfolio, 14% of which are now trading at Caa/Ca. That’s deep into speculative, or “junk,” territory. It’s also a percentage close to the 16% considered distressed during the 2008/2009 period, said a Moody’s report led by retail analyst Charles O’Shea. The rise is part of a wider trend affecting sectors across Moody’s coverage that has retail replacing oil and gas as the most-troubled industry.
Retailers are in the midst of a secular shift to online sales led by juggernaut Amazon.com Inc. AMZN, +0.28% and that’s forcing many of them to spend heavily on their e-commerce operations. At the same time, mall traffic has slowed dramatically as consumer behavior changes, forcing many to discount heavily, hurting profit margins.
The 19 issuers on Moody’s list have more than $3.7 billion of debt maturing in the next five years, with about 30% of that total coming due by the end of 2018. The number is even higher when private credit is included.
“While credit markets continue to provide ready access for companies spanning the rating spectrum—allowing many to proactively refinance debt and bolster balance sheets—that could change abruptly if market conditions or investor sentiment shift,” said O’Shea.
The increase in distressed retailers comes after a long period of low interest rates, during which sponsor activity speeded up to meet investor appetite for yield. Each leveraged buyout cycle tends to produce a new pool of B2/B3 companies, a number of which inevitably get downgraded to Caa, said O’Shea. That was the case for Claire’s Stores Inc., J. Crew Group parent Chinos Intermediate Holdings A Inc., Tops Holding II Corp., and Rue 21 Inc., all of which now have weak credit metrics after taking on high levels of leverage to fund buyouts.
LBOs almost always start life with high leverage, because sponsors are incentivized to minimize equity and maximize debt in each deal to ensure their own returns.
“These companies are frequently challenged from the start, with weak credit metrics,” said O’Shea. “Exacerbating this is the cadence of distributions to boost sponsor returns that typically follow, pushing the leverage envelope. When a highly leveraged company faces operating difficulties, Caa is the usual result.”
That makes companies more vulnerable to default if credit markets tighten, as they tend to tap external sources of uncommitted capital to fund maturities. Moody’s is expecting the overall speculative-grade default rate to fall to 3.5% in January 2017 from 5.8% last January.
It did not provide a default rate forecast for retailers alone. But Fitch Ratings said recently it expects the default rate for the sector to spike to 9% in 2017 from its current 1% trailing 12-months level.
S&P Global Ratings, meanwhile, said the majority of outlooks across retail and restaurants are stable but the ratings trends are negative.
“Shifting consumer preferences and patches of global economic and policy uncertainty are contributing to the increasingly negative outlook bias,” the agency said in a recent report.
The main factors causing downgrades are stressed liquidity, weak credit profiles, challenged competitive positions, sponsor ownership and erratic management structures, said Moody’s. Anytime there is a sudden change in the C-suite, credit risk rises and the rise will be exacerbated if there is no clear successor in sight.
Wal-Mart Stores Inc. WMT, -0.90% and Costco Wholesale Corp. COST, +0.03% two of Moody’s highest rated retailers, have changed CEOs in the past few years without any bumps because of succession planning, said O’Shea.
A bigger pool of low-rated retailers also poses challenges for their stronger competitors, he said.
“As they struggle to survive, distressed retailers can take more desperate measures, including highly promotional pricing that can border on irrational. This leaves stronger firms with the choice of either competing in a race to the bottom, or giving up sales in order to preserve margin.”
See also: Sears is ‘one sick puppy,’ and there may be no remedy
Other retailers on Moody’s list include Sears Holding Corp. SHLD, +3.88% Bon-Ton Stores Inc. BONT, -1.60% 99 Cents Only Stores Inc., Nine West Holdings Inc., True Religion Apparel Inc. and Fairway Group Holdings Corp.
The SPDR S&P Retail exchange-traded fund is up a paltry 1.6% in the last 12 months, while the S&P 500 SPX, +0.10% has gained 22%.
