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Bankruptcy Risk Heating Up in Retail

Retail could see a new wave of bankruptcies before the year’s over.

At CommerceNext last week, Forrester analyst Sucharita Kodali said the sector will “definitely” see more bankruptcies this year than last, when corporate collapses far under-paced 2020’s stunning freefall.

And the risk of default in the apparel retail sector has ticked up sharply, according to new S&P Global Market Intelligence data published this month. The report shows that companies in the sector have a 4.6 percent chance of defaulting on financial obligations in the next year, up from 3.3 percent in May. Instability has infiltrated many areas of retail, with those in apparel, accessories and luxury goods (3.9 percent from 2.5 percent), department stores (steady at 3.6 percent), footwear (2 percent from 1.4 percent,) and internet firms (7.7 percent from 6.7 percent) all in the line of fire. Home furnishing retailers saw their risk dip 0.1 percent to 6.4 percent, the report said.

Many companies in fashion and retail are straining under debt loads similar to what they were carrying in 2019, but this time they’re also dealing with a wildly unpredictable supply chain and overstuffed inventories that will only move with markdowns. Some companies have been caught off guard by the sudden change in what consumers are buying and are bracing for a hit to margins and profits if the discounts come creeping back in.

Will holiday see a glut of promotions after retail was able to pull back last year?

Walter Loeb, an alum of both Macy’s, as well as Morgan Stanley’s retail analyst team, expects a “decent” holiday ahead.

“Many retailers have planned for a promotional holiday season. They’ve already placed orders, with lots of good merchandise,” he added.

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Some retailers nimble enough to read the room pivoted in the spring when Easter sales failed to materialize and ended up reworking their holiday plans in the process. Still, the sector has to contend with the disruption likely to come from a flood of cargo inundating supply chains when China fully resumes shipping after recent zero-Covid lockdowns. Then there’s the West Coast dockworker negotiations likely to stretch past the July 1 date when the ILWU’s current contract is set to expire. Loeb said retailers are counting on an orderly resolution, even if “government interference might be needed.” The federal government can send in mediators under Federal Mediation and Conciliation Service to assist, and federal labor law authorizes the government to end a strike or lockout.

Retailers that moved up their orders are seeing that strategy backfire as stock is piling up. However, softlines inventory seems more manageable when in-transit goods are removed from the equation, though retailers could still struggle to deliver healthy gross margins, according to UBS retail analyst Jay Sole.

The analyst advised clients to sell their holdings in Nordstrom, Dillard’s, Macy’s, and Kohl’s, while he said Ross, Burlington, Steve Madden, VF Corp., Lululemon and Columbia Sportswear could miss Wall Street’s gross margin projections for Q2.

“The biggest variable impacting how quickly and effectively companies can clear excess inventory is consumer demand. The other key variable is how companies choose to manage inventory,” Sole said. “Companies may be more hesitant than normal to reduce prices on excess inventory, since the cost of replacing this inventory will be high, due to inflation.”

Back-to-school assortments are already arriving in stores, and holiday merchandise should land in late August.

Meanwhile, BMO Capital Markets analyst Simeon Siegel reviewed 23 firms’ borrowing activity to determine that retailers’ median gross leverage is hovering around 2019 levels, he found in a debt report.

“This quarter saw more companies choose to tap short-term borrowings to shore up liquidity or fund repurchase activity, with a few select pay-downs for near-term debt maturities,” he said.

With interest rates on the rise, new debt taken on or refinancing existing loans will also become more expensive in the months ahead.

Michael Kors owner Capri Holdings paid down loans taken out early in the pandemic, according to Siegel. Coach parent Tapestry also improved its gross leverage. In contrast, The RealReal, Gap Inc. and American Eagle Outfitters now are balancing a bigger net debt than they had been in recent months.

Operating cash flow (OCF) declined versus a year ago, he pointed out. In total, only six of the companies Seigel tracked, including Nordstrom and Revolve, “reported an improvement in OCF dollars,” when compared with the first quarter of 2019.”

The broader uptick in debt “will be worth monitoring” amid fears of a consumer slowdown, Siegel noted.