It’s a case of the haves and the have-nots.
This story first appeared in the September 15, 2008 issue of WWD. Subscribe Today.
Companies with money are able to attract more money and businesses that need cash the most can’t get it during an economic slowdown.
But even well-funded retailers are finding that the credit crunch triggered by the decline in the housing market is making it more expensive and inconvenient to borrow. They are paying higher interest rates and accepting more onerous covenants on loans from the public bond markets and banks, and giving up some financial flexibility.
“It’s a real increase of expenses,” said Ed Henderson, vice president and senior analyst at debt rating agency Moody’s Investors Service, who studies department store debt and sees little relief on the horizon. “We think that it could get slightly worse before it gets better, but the timing is really uncertain.”
Henderson said most department stores would face higher costs this fall when they borrow to fill their stores with goods for the second half. Some will turn to the commercial paper markets, which offer corporations large short-term loans.
“To the extent some of them go into the commercial paper market as they build up their inventory this fall, those costs are going up as well,” he said. “Some of them have less access to the commercial paper market because of downgrades or whatever.”
In extreme cases, where marginal players have tattered balance sheets or questionable business models, willing lenders disappear and firms wind up in bankruptcy court, as has been the case for Mervyns, Boscov’s, Goody’s, Steve & Barry’s and others. The cost of money doesn’t make emerging from bankruptcy any easier, either: The term loans in Goody’s debtor-in-possession facility carry interest rates of 15 and 14 percent.
But even for solvent retailers, the cost of doing business becomes more expensive.
“The investment grade companies, they’ve been able to issue debt,” said Monica Aggarwal, credit analyst at Fitch Ratings. “It has obviously come at a higher cost and sometimes with more restrictive terms.”
When companies issue bonds, the rating agencies gauge how likely a firm is to pay up when those obligations come due. Companies with investment grade debt are deemed less likely to default than those with non-investment grade, or junk, bonds.
When bonds, sometimes called notes, come due, such as was the case for Macy’s Inc. this year, companies often have to bite the bullet when they refinance.
In June, Macy’s offered $650 million in senior notes, which bore an interest rate of 7.875 percent annually until 2015. That basically means people who buy the bonds are lending Macy’s money and getting that interest payment in return. The firm said it may use the proceeds to pay off $500 million in 6.625 percent notes and $150 million of 5.95 percent notes, each of which were coming due this year.
In addition to forking out more money in interest payments, Macy’s also agreed that if there was a change of control at the retailer that led to debt rating downgrades, the company would offer to buy back the bonds at 101 percent of their principal amount, plus interest due.
All of this adds up to less financial flexibility.
Saks Inc. is taking a slightly different tack and plans to pay off notes coming due in November with cash on hand, drawing down its revolving credit line or both.
Other companies might also go this route, said Fitch’s Aggarwal.
“You would typically use your credit facility to finance working capital needs,” she said. “You wouldn’t necessarily use it in a normal capital environment to refinance upcoming debt. In the near term, they might use it to do that because they have to kind of wait for the credit markets to open up again.”
Because of the credit crunch, as well as the weak consumer environment, companies are cutting overhead and capital expenditures, which means less aggressive store expansion plans or even reductions, trims at headquarters and, if things get bad enough, changes at the stores themselves.
Retailers have also curtailed stock buyback programs, which had been funded by debt. “I don’t think that 2009 is going to be a good year for retail, so as long as the economy is shaky I don’t see people issuing debt to buy back shares,” said Diane Shand, credit analyst at Standard & Poor’s. “I think people want, in this environment, to have a solid balance sheet.”
When companies buy back their own shares, they concentrate ownership and the stock still on the market becomes intrinsically more valuable.
Macy’s, again, is an example of a company that borrowed money to buy back stock and may be paying somewhat more in the long run than they bargained for.
“They levered up to buy back shares,” Shand said. “Their investment in their stock, it turns out, wasn’t a good investment because the stock is lower and they have less flexibility now because of the leverage [or debt].”