WWD.com/business-news/financial/credit-crisis-puts-debt-front-and-center-1838308/

In the new era of supertight credit, fashion’s becoming a game of sink or swim.

This story first appeared in the October 20, 2008 issue of WWD.  Subscribe Today.

With credit scarce and business tough, the ability of companies to conserve cash could mark the difference between those who survive and those who don’t.

An examination of debt-to-equity ratios of leading retailers and fashion companies in the U.S. and Europe showed a wide range of indebtedness. Some firms have plenty of funding and cash on hand to cover their IOUs. Wal-Mart Stores Inc., which has a debt-to-equity ratio of 1.5, is seen as having a winning business model for the down market — and also has a $6.9 billion cash war chest. In England, Marks and Spencer Group plc has a debt-to-equity ratio of 2.65, but analysts are not overly concerned about the firm’s ability to pay its bills or service its debt.

Not everyone is perceived to be as steady, however.

Macy’s Inc., for instance, has a debt-to-equity ratio of 1.85 and has been dogged by liquidity concerns for months, though J.P. Morgan Chase & Co. analyst Charles Grom on Friday upgraded the company’s stock to “overweight” from “neutral” and tried to dispel fears of credit problems.

Grom described the retailer’s stock as “dirt cheap.” Friday’s close of $9.84 was off 2.1 percent for the day, but marked a fall of 70.9 percent from the stock’s 52-week high.

“This upgrade is not for the faint of heart as the fundamentals at [Macy’s] — and across most of retail for that matter — remain extremely stressed,” he said.

Macy’s has plenty of access to cash and is able to meet its debt requirement, Grom said in painting the firm’s financing profile.

Macy’s repaid $500 million in debt last month and has about $1.1 billion coming due over the next year, including $150 million on Nov. 1, the analyst said. Macy’s will meet these needs with the roughly $740 million of cash on its balance sheet and an estimated $865 million in free cash flow, mostly generated in the fourth quarter, he said.

Perception is vitally important in the area of credit as companies that lose the confidence of their various constituencies, from suppliers and analysts to investors and bankers, can see their problems intensify. Macy’s chairman, president and chief executive officer, Terry Lundgren, demonstrated his understanding of this idea in July, when he wrote a letter to management, filed with the Securities and Exchange Commission, asserting the company was outperforming its peers and was in good fiscal health.

From a financial perspective, the stakes only go up when credit markets tighten.

“Some [retailers] have no problem paying back their debt and making interest payments,” Gerald Hirschberg, Standard & Poor’s debt analyst, said, noting others could have significant troubles.

“It doesn’t look like the credit markets have opened up yet,” Hirschberg said. “We as an organization think the markets are still extremely tight and we have no idea when things will open up.”

The Bush administration and governments around the world have taken a number of dramatic steps to free up credit markets — from buying equity stakes in banks to guaranteeing certain loans. Analysts said it would take time to gauge what impact these steps will have and if they will ultimately be enough to get the global finance system running at full tilt again.

Meanwhile, heavy debt burdens could ultimately alter the retail landscape around the world.

Baugur Group, which has a financial interest in Saks Fifth Avenue parent Saks Inc. and in a variety of British high street retailers, has more than $2 billion worth of debt. The firm is based in Iceland, where the recent financial crisis hit particularly hard. The company has warrants that give it the option to purchase a portion of Saks’ stock.

Sir Philip Green and private investors such as Texas Pacific Group are negotiating with Baugur to buy all or part of its debt in a bid to gain control of some of the retail companies. Industry sources also say that some of the retail groups owned by Baugur — such as Mosaic — are mulling management buy-outs.

Baugur holds a number of stakes in listed companies including French Connection, Moss Bros., Debenhams and Woolworths, and has therefore been highly exposed to their roller-coaster ride on the stock market.

“All of those companies’ share prices have bombed — they’ve lost more than 50 percent of their value since Baugur purchased them,” said Freddie George, a retail research analyst at Seymour Pierce in London, pointing to the source of some of Baugur’s debts.

Retailers generally saw massives swings in their stock values on Wall Street and elsewhere last week, although less so on Friday. Retail shares were mixed, but rose 1.3 percent for the day with the Standard & Poor’s Retail Index gaining 3.6 points to 277.87 — more than 40 percent off its 52-week high.

The market overall fell, with the Dow Jones Industrial Average down 1.4 percent, or 127.04 points, to 8,852.22.

Department stores picking up ground included Saks Inc., up 6.1 percent to $5.73, and The Bon-Ton Stores Inc., up 1.5 percent to $2.04.

Many retailers refinanced during the go-go credit days preceding the subprime mortgage crisis when money was easy to come by and restrictions were few.

Should the weak consumer environment erode sales and earnings quarter after quarter, as many expect, companies unable to pay off their debts will face longer odds as sources of refinancing have tightened or dried up.

“Most retailers have the liquidity to get through this holiday season,” Ed Henderson, vice president and senior analyst at Moody’s Investors Service, said. “When you look into next year, the issue is going to be how bad it is. How bad is the holiday season? How deep this gets? Can it get any worse?”

One of the most important question marks for retailers is one they do have some control over: inventory.

“The critical issue is how much inventory retailers carry over,” Henderson said. “Have they reduced their inventories to a level that matches what the sales level is going to be for the holiday season?”

Companies have largely gone into cash-preservation mode, saving where they can and pulling back in areas such as store expansion and stock repurchases.

“There are some companies that are doing a very good job,” Karen Ghaffari, debt analyst at Fitch Ratings, said. “They’re able to maintain their operating margins. Gap has done a pretty good job of maintaining operating margins.”

Not everybody will perform so well. The tough holiday season expected by many could serve as a crucible for the fashion industry.

“It could be a slow death for some companies,” Ghaffari said. “On the other side of holiday, we’ll start to see who the stronger players are and who are the weaker players. At that point, we’ll probably see more about store closings. Once we get on the other side of this economic downturn, I think we’ll probably see more consolidation in this industry.”

The problem isn’t restricted to the U.S. In Europe, IT Holding SpA is considered by some to be one of the most vulnerable in light of the credit crunch.

The Italian fashion group, which owns the Gianfranco Ferré, Malo and Extè brands and operates under license the Just Cavalli, C’N’C Costume National and Galliano labels, has underperformed the Milan Bourse by about 30 percent in the last six months, weighed down by debt of almost 318 million euros, or $432 million at current exchange, including an expensive 185 million euro, or $251 million, bond that expires in 2012.

IT Holding chairman Tonino Perna said in June the stock was undervalued, but financial sources said the firm’s debt helped explain the low share price.

Last month, credit rating agencies Moody’s and Standard & Poors downgraded their outlook on the stock to “negative” on concerns a decline in consumer spending is hurting earnings.

Compounding matters, IT Holding’s parent company PA Investments SA is saddled with around 140 million euros, or $190 million, in debt.

“Those who are the most fragile asset-wise are suffering the most from the crisis,” Abaxbank analyst Elena Sottanella said.

“The worsening of operating results, which became more pronounced after the second quarter due to the crisis in play, has not allowed IT Holding the capital strengthening indicated by the company in last year’s plan,” she said. “The consequence is that the elevated financial burden is eroding business performance.”