Traditional brick-and-mortar retailers that fail often blame debt and the consumer shift to e-commerce as reasons for shortcomings on their balance sheet—but too many doors and a declining middle-class population have also contributed to the problem.
Data from the high number of U.S. retailers that have filed for bankruptcy court protection in 2017 and 2018 have provided clues on several key factors that led to their collapse, according to new insight from Coresight Research.
Some of the major retailers that filed in those years include Sears Holdings, Bon-Ton Stores, Toys “R” Us and Mattress Firm. And so far in 2019, a number of retailers already have filed, with a few, like Payless ShoeSource, Gymboree and Shopko, in the process of liquidating their operations. Both Payless and Gymboree are also examples of retailers that filed in 2017, came out, and then joined the so-called Chapter 22 club when they filed again earlier this year.
This year’s filers did so during a period when the National Retail Federation had forecasted that U.S. retail sales would grow 3.8 to 4.4 percent, Coresight pointed out. And while 2019’s projected growth rate is slower than the 4.3 percent in 2018, it’s still fairly strong against the backdrop of a potential economic slowdown and ongoing U.S.-China trade tensions. Retailers tracked by Coresight run the gamut from department stores to food chains, footwear companies and home improvement stores.
“In the past two years, more than 50 retailers have filed for bankruptcy protection,” Coresight said. “So far in 2019, the situation has remained severe as some retailers continue to face declining store traffic, a liquidity crunch, management challenges, weakened competitive positions and ailing credit ratings.”
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To be sure, a high amount of debt on the balance sheet leaves one open to financial pressures when consumers elect to shop elsewhere. One example is the more than $5 billion leveraged buyout of Toys “R” Us. And while the toy retailer could claim online competitors like Amazon helped deplete sales from stores, Toys was also hampered by its own failure to fully embrace the e-commerce channel.
The saturation of U.S. physical store space has also become a burden for most retailers, according to Coresight, which found that between 1970 and 2015, the “growth rate of malls in the U.S. was more than double the growth rate of the population.” In a 2016 study, Morningstar concluded that the U.S. has more retail space per person than other countries, at 23.5 square feet per capita compared with 16.4 in Canada and 11.1 in Australia.
Coresight also found that, according to a Pew Research Center analysis of the U.S. Census Bureau data, the middle class fell to just 50 percent of the population in 2015 from 61 percent in 1971. This particular demographic group was hit hard by the Great Recession that began in late 2007-early 2008. The research firm said the middle class has never recovered from the financial crisis.
“In the decade since the crisis, consumers have experienced a decline in disposable income, while costs for education and health care surged,” Coresight said. “Traditional retailers such as Macy’s and Sears relied on spending from this segment, and their shrinking numbers and spending power drove severe sales declines.”
There are two different types of debt that caused balance sheet problems among retailers. The kind placed on the balance sheet from LBOs, such as Toys, left massive debt mostly because “private equity firms used corporate cash reserves pay themselves back,” Coresight said. And since 2002, more than 15 percent of retailers acquired through an LBO have filed for Chapter 11 bankruptcy court protection through 2018. These retailers, in addition to Toys, include: in 2018, Nine West, Brookstone and Claire’s; in 2017, Gymboree, Rue21, Payless, The Limited and True Religion; in 2016, Sports Authority; in 2011, Deb Shops and; in 2009, Linens N’ Things.
The other form of debt, such as with Sears and Bon-Ton, has had more to do with sizable borrowings to stabilize and try to grow the brick-and-mortar stores or build out the infrastructure for e-commerce. Difficulties surface when the debt comes due and retailers can’t refinance either due to rising interest rates or because there’s not enough revenue coming in to help pay down the debt as consumers have gone elsewhere to shop.
One other factor noted in the report has to do with the change in the bankruptcy laws in 2005, which now requires just 120 days from filing to propose a reorganization plan. The new law also requires retailers to know within 210 days of filing which store leases it wants to keep or reject. That makes it harder for retailers to negotiate a debt restructuring with creditors. And when they do, many often exit bankruptcy proceedings with a balance sheet that looks better due to the reduction in debt, but they also remain saddled with an operating model that’s still relatively weak.
Sears is one example that will be a wait-and-see story.
The company emerged with 425 fewer stores, but overhead cost-cutting leaves it with nearly no marketing budget. And it still needs to figure out how it will pay for the new smaller stores it plans to open. On Thursday, Sears said it plans to open three Home & Life stores in Anchorage, AK; Lafayette, LA, and Overland Park, KS. That was why the creditor constituency groups were pushing for a liquidation. The way they see it, there’s a good chance Sears might be facing a Chapter 22, and in their eyes, the retailer’s assets have more value now to give back to creditors than further down the road.