Why retail is facing a wave of bankruptcies

Revlon makeup products will be displayed in a CVS store on August 9, 2018 in Sausalito, California.

Justin Sullivan | Getty pictures

Retail is up against a potential wave of bankruptcies after a month-long decline in restructuring activity.

There may be an increase in distressed retailers starting later this year, experts say, as prices increase demand for certain goods, stores are struggling with inflated inventory levels and a potential recession.

Last week, the 90-year-old cosmetics giant Revlon applied for Chapter 11 bankruptcy protection, making it the first household consumer-facing name to do so in months.

Now the questions are: Which dealer will be next? And how soon?

“Retail is changing,” said Perry Mandarino, co-head of investment banking and head of corporate restructuring at B. Riley Securities. “And over the next five years, the landscape will be much different than it is today.”

The industry had seen a dramatic decline in restructuring in 2021 and early 2022, when companies – including those on so-called bankruptcy watch lists – received relief from fiscal stimulus that offered cash infusions to businesses and stimulus dollars to consumers. The break followed a flood of distress in 2020, near the start of the pandemic, when dozens of retailers including JC Penney, Brooks Brothers, J. Crew and Neiman Marcus went to bankruptcy.

Including Revlon’s filing, there have been only four retail bankruptcies so far this year, according to S&P Global Market Intelligence. This is the lowest number the company has tracked in at least 12 years.

It is not entirely clear when those numbers may begin to grow, but restructuring experts say they are preparing for more problems in the industry as the important holiday season approaches.

An analysis by Fitch Ratings shows that the consumer and retail companies most at risk of default include mattress manufacturer Serta Simmons, cosmetics line Anastasia Beverly Hills, skin care marketing company Rodan & Fields, Billabong owner Boardriders, men’s wearwear clothing chain, dietary supplements marketing. the company Isagenix International and the sportswear manufacturer Outerstuff.

“We have potentially a perfect storm going on,” said Sally Henry, professor of law at Texas Tech Law School and former partner at Skadden, Arps, Slate, Meagher & Flom LLP. “I would not be surprised to see an increase in retail bankruptcies.”

Advisers who have worked with retail bankruptcies in recent years still believe, for the most part, that any looming crisis in the industry should not be as intense as the massive shakeout in 2020. Instead, bankruptcies may be more widespread, they said.

“What you saw in 2020 was a huge amount of restructuring activity that was highlighted,” said Spencer Ware, CEO and head of retail at Riveron, a consulting firm. “Then we came from 2020 to today with an enormous amount of stimulus. What is going to happen now? It’s a bit mixed.”

A split in consumer behavior can make things more unpredictable. Lower-income Americans have been particularly squeezed by inflation, while richer consumers continue to splurge on luxury goods.

“We are in a moment now when we predict that what will happen next is far more complicated,” said Steve Zelin, partner and global head of the restructuring and special situations group at PJT Partners. “There are many more variables.”

The clearance rack at TJ Maxx’s clothing store in Annapolis, Maryland, May 16, 2022, as Americans prepare for summer sticker shock as inflation continues to grow.

Jim Watson | AFP | Getty pictures

The latest retail sales data show where consumers withdraw the most. Advance spending on retail and food service fell 0.3% in May compared with the previous month, the Ministry of Trade reported last week. Furniture and home furnishings retailers, electronics and white goods stores and health and personal care chains have all declined from month to month.

“Consumers are not just buying smaller things, they are shopping less, which means losing momentum-shopping moments that are crucial to retail growth,” said Marshal Cohen, head of the retail industry at NPD Group, a market research firm.

In the first three months of 2022, consumers bought 6% fewer retail items than they did in the first quarter of 2021, the NPD Group said in a survey released in late May. More than 8 in 10 US consumers said they plan to make further changes to reduce their spending over the next three to six months, it said.

A race to stay ahead of rising rates

The threat of future interest rate hikes – after the Federal Reserve last week raised reference rates by three quarters of a percentage point in its most aggressive increase since 1994 – has prompted retailers to take advantage of debt markets to accelerate these plans.

Riveron’s Ware said companies had struggled to catch up with future rate hikes. Some bought back debt or tried to squeeze out maturities. For example, the department store chain Macy’s said in March that it had completed the refinancing of $ 850 million in bonds maturing over the next two years.

More recently, however, Ware said he has noticed that refinancing activity has begun to decline in the last 12 months, with a larger number of agreements being canceled or withdrawn. “The window seems to be closing for more difficult refinancing,” Ware said.

At the end of 2020, Revlon barely escaped bankruptcy by persuading bondholders to extend their overdue debt. But a little less than two years later, the company succumbed to a large debt burden and supply chain problems that prevented it from fulfilling all its orders.

As has always been the case, retailers struggling with the heaviest debt burdens will be the most vulnerable to bankruptcy, said David Berliner, head of BDO’s restructuring and turnaround operations.

More distress may begin to emerge after the upcoming shopping season for back to school, he added, after families return from long-awaited summer vacations and may be forced to tighten their belts.

A survey by UBS earlier this month found that only around 39% of American consumers said they plan to spend more money on the school start season this year compared to the year before, down from the number of people who said the same thing in 2021.

“Consumers are becoming more stingy with their wallets,” Berliner said. “There are going to be winners and losers as we always see. I’m just not sure yet how soon that’s going to happen.”

Berliner said he has been keeping a close eye on consumer debt levels, which are hovering near all-time highs.

“Consumers have been willing to spend on credit cards, on mortgages and on buy now, pay later programs,” he said. “I’m afraid many consumers will take out their credit cards and then they will be forced into an abrupt withdrawal.”

If consumer spending declined that way, more retailers could be forced into bankruptcy at a faster pace, Berliner said. But if spending remains at a reasonable level and consumers are able to pay down their debt, companies will instead “share some of the pain” with fewer bankruptcies, he said.

In any case, Berliner said that the need will be greater among smaller retail companies, especially mom and pop stores, which do not have as many resources to cope with more difficult times.

Stock levels on the watch

Rising stock levels are also on the bankruptcy advisers’ radar because they have the potential to lead to much bigger problems. Retailers from Gap to Abercrombie & Fitch to Kohl’s have said in recent weeks that they have too much stuff after shipments arrived late and consumers abruptly changed what they were shopping for.

Target said earlier this month that they are planning a reduction and canceling some orders to try to get rid of unwanted items. As other retailers follow suit, profits will contract in the short term, said Joseph Malfitano, founder of the turnaround and restructuring firm Malfitano Partners.

And when a retailer’s profit margins shrink when inventory is reassessed – a routine practice in the industry – these inventories will not be worth as much, Malfitano explained. A company’s loan base could fall as a result, he said.

“Some retailers have been able to cancel orders so as not to create more of a bubble in the inventory. But many retailers cannot cancel these orders,” Malfitano said. “So if retailers who can’t cancel orders don’t knock it out of the park during the holidays, their margins will go down a lot.”

“You’ll have more problems in 2023,” he added.

Shoppers will be seen inside a mall in Bethesda, Maryland on February 17, 2022.

Mandel Ngan | AFP | Getty pictures

Ian Fredericks, president of Hilco Global’s retail group, agreed that retail bankruptcies are unlikely to pick up until 2023.

“Dealers are not in need because they are still sitting on a boatload of liquidity … between some cash left on the balance sheet plus a drawn revolver,” he said. “There’s still a lot of runway.”

It just means that the upcoming holiday season, which every year is an important time in the retail calendar for companies to balance profits, can be even more of a make-or-break moment for companies.

“I do not see a big holiday spending season. I think people are going to really tighten up and buckle down,” Fredericks said. “Inflation is not going anywhere.”

A further result of an economic downturn could be an increase in M&A activity in retail, according to B. Riley Securities’ Mandarino.

Larger retailers who are more financially stable can look to devour smaller brands, especially when they can do so at a discount. They would use this strategy in tough times to continue to increase revenue quarter after quarter, albeit inorganically, Mandarino said.

Home goods, clothing and department stores may face the most pressure in the months ahead, he added.

With Bed Bath & Beyond’s namesake underperforming in recent quarters, the retailer has faced pressure from an activist to stand out from the Buybuy Baby chain, which is seen as a stronger part of the business. Kohl’s, a department store retailer outside the mall, also came under activist pressure to consider a sale and is now in exclusive contract talks with Franchise Group, the owner of Vitamin Shoppe. The franchise group is considering whether to lower its bid for Kohl’s, a source told CNBC on Wednesday.

“It’s a buyer’s market,” Mandarino said. “Growth will not come organically when consumption goes down and if we go into a recession.”