One down—how many more to go?
With J.Crew’s bankruptcy filing now a done deal, all eyes are on Neiman Marcus and J.C. Penney Co. Inc. But others in the sector could be at risk, too.
The classic American clothier’s turn through bankruptcy court could be the “first in a wave of defaults among retailers with weak balance sheets,” said Raya Sokolyanska, vice president at credit ratings firm Moody’s Investors Service.
“The impact of coronavirus-related disruption will be felt very acutely within the apparel sector, which has already undergone significant challenges over the past several years and now needs to unload stale inventory to raise cash,” Sokolyanska added.
As it turns out, J.Crew has earned the dubious distinction of being the “largest retailer to default since Neiman Marcus’ distressed debt exchange in mid-2019,” according to David Silverman, Fitch Ratings’ senior director and retail analyst. Not only that, but the firm’s filing has also pushed Fitch’s retail loan default up two percentage points to 9 percent from 7 percent at the end of April, he added.
Silverman cited GNC and Lands’ End as similarly “challenged retailers” with maturities this year or early next, while Penney’s and Neiman—both of which have recently failed to make interest payments—could wind up restructuring “in the near term.”
Retailers at risk
Still in talks with potential lenders, Neiman now sees its default deadline rapidly approaching after the missed interest payment. Though it completed a distressed debt exchange last year, the luxury department store retailer’s business came out of the process still somewhat shaky, given its high debt and leveraged balance sheet.
Financiers believed the retailer probably had enough funding to get through the end of 2020, but that was before the coronavirus pandemic hit in mid-March. COVID-19 effectively accelerated and exacerbated weak retailers’ financial issues, forcing them into a liquidity crunch sooner than later now as brick-and-mortar sales evaporated in the wake of store shutdowns.
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And Penney’s, too, is not far behind. With its default deadline just days away on May 15, Penney’s had another headache on its hands on Monday as a 16-year relationship with beauty retailer Sephora could be on the brink over COVID-19. The LVMH-owned purveyor of skincare, cosmetics and fragrances–which operates shop-in-shops inside many of Penney’s doors—is eyeing a shutdown of the in-store boutiques given Penney’s financial pressures, and it’s asking the department store chain to sanitize all hard surfaces. The matter is currently in litigation in a federal court in Sherman, Texas, according to Bloomberg, which also reported that Sephora doesn’t want to send any more product to the in-store boutiques. Penney’s, which is expected to re-open nine stores this week, is asking the court to bar Sephora from closing down the boutiques, which represents the mass merchant’s only beauty supplier.
The list of distressed retailers goes on.
Recently acquired by fashion subscription platform Le Tote from Hudson’s Bay Co. for $100 million, Lord and Taylor is believed to be gearing up for a bankruptcy filing, but there are also questions about the future of LeTote, where layoffs hit both operations last month. And Stage Stores is said by factors to be in discussions with vendors about delaying payments so it can keep its lights on and avoid a bankruptcy filing. The company was in the midst of converting its department stores to its off-price concept Gordmans, but then in mid-March shuttered all doors to help curtail the spread of COVID-19.
On Friday, Moody’s updated its list of retailers believed to be at an increased risk of default, thanks to weak credit ratings. Belk, the department store operation owned by Sycamore Partners, landed on the list along with Boardriders Inc., which owns the surf brands Quiksilver and Billabong, joining Academy, 99 Cents Only Stores, Neiman, Penney’s and J.Crew. Other retailers include Jill Acquisition, which operates the J.Jill retail brand, and Ascena Retail Group, the owner of brands such as Ann Taylor, Loft, Lane Bryant and Justice. Ascena investors were concerned in March about a possible bankruptcy, but the company sought to ease those concerns by noting that a Chapter 11 filing is “not being considered.”
Others that have already filed include True Religion in the U.S. and Debenhams, which filed for insolvency across the pond.
Breaking down J.Crew’s bankruptcy
As for J.Crew, the retailer expects to receive interim approval from a federal bankruptcy court of its $400 million debtor-in-possession (DIP) financing facility this week, and then file a plan for reorganization by May 18, according to court documents filed in Richmond, Va. Presuming all other procedures follow the retailer’s planned timeline without any delays, J.Crew expects to exit Chapter. 11 by Sept. 11.
The company reached an agreement with lenders to convert $1.65 billion in debt to equity. Essentially, it is an agreement in which the lenders have already agreed to become equity owners in the company, and that’s why it is called a pre-packaged bankruptcy. That also means that current owners TPG Capital and Leonard Green & Partners, who took J.Crew private through a leveraged buyout in 2011 that dropped too much debt on the retailer’s balance sheet—will end up seeing their equity stake get wiped out. Generally, unsecured pre-petition vendors who supplied goods and services before the petition date will have to see what amount is set aside to pay for pre-petition claims. Post-petition vendors will get paid for goods and services from the DIP facility.
“Like thousands of business across the world, the debtors have been operating under the considerable financial strain caused by the pandemic, while trying to preserve the health and safety of over 10,000 employees. The temporary closure of approximately 500 retail stores worldwide and the disruption to the debtors’ customer base and supply chain have only exacerbated the debtors’ issues related to substantial funded debt obligations and significant lease obligations,” Michael J. Nicholson, president and chief operating officer of Chinos Holdings Inc., parent company to J.Crew Group, said in a declaratory statement filed with the bankruptcy court Monday.
J.Crew Group Inc., which has 181 stores around the world, still operates its flagship retail store in the South Street Seaport in Manhattan that was first opened in 1983, Nicholson said. It also operates 170 J.Crew Factory brand outlet doors. J.Crew contributed 67.2 percent of revenue, or $1.71 billion, for fiscal year 2019. Total revenues for J.Crew Group in fiscal year 2019 reached $2.45 billion.
The balance in fiscal 2019 revenue came from $230 million in wholesale sales and from its Madewell concept, founded in 2006. Best known for its premium jeans business at value prices–Madewell’s The Denim Bar favorites average $100 a pair–the concept contributed 23.7 percent of revenue, or $602.4 million in fiscal year 2019, to J.Crew Group’s bottom line.
Nicholson said the company historically does business with more than 200 vendors located outside the U.S., with the top 10 suppliers providing 32 percent of its merchandise. It works with buying agents who identify suitable vendors and then place orders with them for the retailer. Last year, 87 percent of its merchandise was sourced in Asia, with 45 percent sourced from Mainland China and 16 percent from Vietnam. It also sources 12 percent from Europe and other regions and just 1 percent in the U.S. The company employed 13,000 people–4,000 full time and 9,000 part time–worldwide, but began furloughs on April 1. It now has just 2,000 active full-time employees.
Nicholson said J.Crew has 140 landlords and has about 500 unexpired leases. Most lease terms are between five and 10 years, and the company has about $23 million in monthly lease obligations. The company is working with Hilco Real Estate, and if it can’t secure certain adjustments, Nicholson said it will probably walk away from some leases, which would mean closing select stores. In addition, J.Crew’s cash interest expenses saw it paying $143 million in fiscal year 2019.
“The debt service obligations impacted the debtors’ ability to make capital expenditures, including to refresh store locations, drive growth initiatives and further enhance their customer experience,” Nicholson said.