The Supply Side: Retail bankruptcies hasten in wake of COVID-19 pandemic

The financial impact from the COVID-19 (coronavirus) pandemic has hit the retail segment hard as thousands of stores were temporarily closed and millions of employees were furloughed and told to remain at home. The pandemic came when many retailers already had weak financial statements, taking on large sums of debt during the recent period of cheap money and low-interest rates.

Companies overleveraging will likely be the final nail in the coffin for dozens of retailers in the coming months as they struggle to reopen and regain sales traction while continuing to bleed hefty losses. Prominent names already filing Chapter 11 bankruptcy in May include Neiman Marcus, J.Crew, Stage Stores and JCPenney.

Pier I Imports Inc., the Texas-based home decor retailer, declared bankruptcy in February. Now it has asked the bankruptcy court to approve a complete liquidation of the chain. Tuesday Morning, focused on off-price home goods, filed Chapter 11 bankruptcy May 27, with plans to permanently close about 230 of its 687 stores. The retailer cites the prolonged closure of its stores amid COVID-19 as an “insurmountable financial hurdle.”

While serving different customer bases, the retailers suffered from the same issue — excessive debt that could not be serviced with stores across the nation closed since mid-March from COVID-19 shutdowns.

Veteran retail consultant Walter Loeb warned this would be another assault on shopping malls if JCPenney fails to come out of bankruptcy. He said the most likely scenario would be for an investor group to acquire the chain, following the example of Authentic Brands Group (ABG), Simon Property Group and Brookfield Property Partners. They jointly acquired Forever 21 in February.

Loeb said JCPenney would have to close some stores in unprofitable locations. He said if the department store fails to emerge from bankruptcy, there could be a domino effect that will force more mall closures.

Jan Kniffen, a consultant with J. Rogers Kniffen Worldwide, expects the landscape to be strewn with bankruptcies in the coming months. Even department stores with well-managed balance sheets and growing online sales have suffered deep losses through the COVID-19 crisis, and they won’t be without their challenges, he told the Northwest Arkansas Business Journal.

Kniffen expects a third of all U.S. malls will struggle to survive as more retailers are forced to reduce store counts. He said over a dozen retailers with large mall presences are at increased risk for bankruptcy since COVID-19 escalated cash flow problems. Kniffen said other mall anchors such as Dillard’s, Nordstrom and Macy’s have the financial wherewithal to survive the COVID-19 crisis, but it won’t be pretty.

Little Rock-based Dillard’s lost $162 million in the first quarter and said there was not sufficient clarity to forecast financial results for the next two quarters. Dillard’s appears to have adequate cash and assets to weather the storm, but analysts expect the chain will reduce its store size by the end of the year.

Nordstrom also continued to innovate and push online growth but plans to close 16 of its least profitable stores permanently. Company executives said the retailer had leveraged $600 million in real estate investments to help it weather the COVID-19 impact. Nordstrom is also “restructuring its regions, support roles and corporate organization for greater speed and flexibility,” the company said. The changes are expected to result in savings of approximately $150 million.

“More than ever, we need to work with flexibility and speed,” Nordstrom CEO Erik Nordstrom said in a prepared statement.

Kniffen said economic fallout from COVID-19 would likely linger for up to nine more quarters. He said most retailers would have to liquidate inventory at deep discounts to generate whatever cash they can.

Analysts with Moody’s said retail is in for a rough ride through 2020. The 12-month default rate forecast for the speculative-grade retail and apparel industry is forecast at 6.7%, down from 11.4% in February — primarily because of a smaller base of distressed issuers left following 10 defaults in 2019. The lower rate masks serious underlying challenges, according to Mickey Chadha, senior credit officer at Moody’s.

“This year, weaker balance sheets and relentless margin pressures will continue to push smaller, cash-starved retailers down the rating scale and closer to default,” Chadha said. “This will be exacerbated by the extreme dislocations caused by the coronavirus pandemic. There is a sharpening divide between those who can weather the challenging operating environment and those who do not. The majority of companies that defaulted in 2019 and year-to-date 2020, such as Charlotte Russe, David’s Bridal, 99 Cents [Only] and Pier 1, did not have the scale, the pricing power, or the deep pockets that their competitors had.”

He said six retailers holding the most distressed debt are JCPenney, Neiman Marcus, Rite Aid, J.Crew, Ascena Retail Group and Academy Sports + Outdoors. Chadha said those six retailers represent nearly 77% of the $24 billion in outstanding distressed junk bond debt for retail and apparel.

“As struggling retailers contend with high leverage and challenged operating performance, mounting maturities can make matters worse,” he said. “As the retail debt maturities swell to $18.5 billion over 2021 and 2022, those with distressed balance sheets will find it increasingly difficult to refinance.”

Kniffen said L Brands and Gap share similar problems as they each operate one good business in Bath & Body Works and Old Navy, respectively, while the Victoria’s Secret and Gap businesses are in dire straits.

As director of retail studies at Columbia Business School, Mark Cohen said there will be a large number of retailers who will not make it to the other side of COVID-19. He said retailers who typically defaulted on their debt payments in the past had been a harbinger for future bankruptcy.

Cohen predicts COVID-19 will create “retail extinction” for several players who already were in weak positions before the crisis. He said there is likely to be enormous wreckage in the retail sector over the next six months. He said the 2,300 store closures Coresight Research reports could hit the 30,000 mark if the country remains closed for most commerce.

“When normalcy returns — and that could take 18 months — those retailers who were strong going into COVID-19 will be stronger, and those who were distressed will emerge weaker or be completely gone,” Cohen said.

Editor’s note: The Supply Side section of Talk Business & Politics focuses on the companies, organizations, issues and individuals engaged in providing products and services to retailers. The Supply Side is managed by Talk Business & Politics and sponsored by Propak Logistics.