The poisonous combination of tight credit and limited spending is setting the stage for a dramatic and frightening start to the new year.
This story first appeared in the December 31, 2008 issue of WWD. Subscribe Today.
Financial and credit sources expect 2009 to be difficult from beginning to end, but the first few months will be critical as stores weigh the damage wrought by soft holiday demand, heavy markdowns to drive traffic and expected weak fourth-quarter profits.
William R. Wagner, partner in the banking and finance practice at the Baker & McKenzie law firm, said, “I think we will continue to see many financing issues throughout 2009. We have certainly hit some difficult times. Some people think we are at or near the bottom. So far, I haven’t seen liquidity hit the market yet. I expect we’ll see an increasing combination of bankruptcy activity and distressed investing during the next six months.”
Wagner said retailers are significantly exposed to the liquidity crunch since they operate on a “seasonal buy-sell curve, and this downturn, in particular, is hitting their biggest season, essentially handcuffing them.”
In the current environment, he explained, many retailers face increasing pressure to meet their financing obligations under loan agreements. That pressure, coupled with a real uncertainty over how much consumers may be willing to spend during the holiday season, has led to major spikes in discounting as retailers do their best to end the holidays with a pile of cash to finance the next selling season.
“This is so pronounced because every retailer out there is competing against the other,” Wagner said. “Even Nordstrom is competing with TJ Maxx, trying to get that last dollar from the consumer. Those that aren’t successful may have real liquidity issues in the first quarter of 2009. From a lawyer’s perspective, lenders have now returned to very tight credit policies. The credit markets are anything but robust, and companies that were able to borrow on liberal terms in the past do not have the same access to cash, creating significant refinancing risks ahead. I believe 2009 will continue to be pressured.”
James Schaye, president and chief executive officer of liquidation firm Hudson Capital Partners LLC, also is pessimistic about 2009.
“I see absolutely nothing at this point in the near future to turn things around,” he said. “People may buy to feel good or feel a little better, but there are no triggers to turn the economy around. The banks are going to exert pressure on companies come January. Most will come out of December with sales that are highly disappointing to everyone. That means the banks are going to look extremely hard at the portfolios. I know of one asset-based lender that said 10 percent of his portfolio is in trouble, and that the percentage could increase.”
To survive the threat, “the smart retailers will get their inventories way down and start turning faster,” he said. “Some are canceling or holding back on orders. But it’ll also back up into the wholesaler as retailers return goods or come back with their hands out for markdown money.”
Steve Victor, a vice president at Development Specialists Inc., a restructuring and workout firm, said consumers are either not spending or trading down.
“Most don’t have any availability on their credit cards and are scaling back. All retailers are affected, from consumer electronics to apparel. It will be an interesting time starting in the middle of January and into February when management and the lenders begin evaluating where they are,” he said.
Calling the times “unprecedented,” he foresees continued pressure throughout next year and is expecting more bankruptcies and corporate downsizing after the holidays.
Consumers, like the businesses trying to snare their purchases, are emphasizing cash conservation. A recent study by global strategy firm L.E.K. Consulting indicated that individuals, deprived of the comfort of wealth creation in real estate or the stock market, will decrease personal consumption and instead emphasize savings in the new year.
“This trend represents a startling reversal, with huge implications for the economy,” said Andrew Rees, vice president and co-author of the study. “If consumers do indeed move the savings rate back to the average over the past 20 years, around 7 percent, that will take between $115 billion to $120 billion out of the consumer economy on a quarterly basis.”
As with all economic downturns, the changes will spell opportunity for some. Gary Wassner, president of Hilldun Factors, believes there are new opportunities out there for American designers.
“When I talk to the stores, they say they can’t sell European product,” he said. “Consumers don’t want to buy. The appeal of the superluxury European brand has gone away among the affluent in this depressive financial mood. It is almost more politically correct to feel better by buying American, which usually has a lower price point even in the luxury market.”
Wassner said American brands offering merchandise typically slightly less expensive than the ultrahigh-end — Alexander Wang, Nanette Lepore, Theory — are the sweet spots among consumers. “Consumers can still buy designer, but at better value prices,” Wassner said.
He is concerned about retailers who cater to the affluent, or those who have mimicked their wardrobe habits. “These companies could be getting strapped because their customer base, the aspirational shoppers, are unwilling to pay high price points for something when the discretionary money is now needed for their kids and their education.”
Wassner is hoping that by the end of 2009 the market will be on the road to recovery. “Everyone is grasping at straws right now. No one knows what will stop the panic. The fundamentals are still good for most companies, but the panic is due to lack of confidence in the financial system. It is really crazy because the panic is feeding on itself.”
Jeffrey Edelman, retail consultant and former analyst, believes the climate will help retail-wholesale partnerships built around exclusive brands, rather than focused on stores’ private labels or vendors’ brands. At a recent presentation sponsored by accounting firm McGladrey & Pullen LLP, he noted, “Private labels can tie up stores’ cash and force them to make buying decisions far in advance of actual selling. Vendors’ brands provide stores with more flexibility but have limitations of their own. Brands are losing their relevance because there’s too much sameness. There’s nothing new, nothing exciting.”
The reluctance of brands to take fashion chances might be understandable given the economic uncertainty, but that has made it easier for many retailers to cut their orders or play it safe. Brands’ caution when it comes to fashion also has made it easier for consumers to sit on their wallets.
Emphasizing private brands can help retailers cut costs in some instances, but private labels also necessitate making commitments far in advance of delivery. The strategy can work, Edelman noted, but is by no means a panacea. Before its Chapter 11 bankruptcy filing in January 1992, R.H. Macy & Co. had “up to one-third [of its goods in] private label, but it couldn’t control costs and it cut many of its other brands, creating an inventory imbalance,” he noted. On the other hand, today more than 35 percent of Macy’s sales come from brands that are either exclusive to its stores, such as Tommy Hilfiger’s sportswear, or limited in distribution, according to the firm.
J.C. Penney Co. Inc. has a number of private label brands that offer good value to consumers, a practice that earns the retailer its “value image,” Edelman said. He noted the midtier retailer also has its share of national brands and maintains a promotional cadence that adds to its value orientation. However, the exclusive brand American Living, developed by Polo Ralph Lauren Corp.’s Global Brand Concepts division, sits at the top of its price structure and could be “a billion-dollar brand as it develops,” Myron “Mike” Ullman 3rd, J.C. Penney’s chairman and chief executive officer, said in August.
Earlier this month, Charlotte Russe Holding Corp. was designated as the exclusive retailer for the People’s Liberation brand. “Partnering becomes extremely important,” Edelman remarked. “If done right, both [retailers and wholesalers] can win.”
Even with growth at discounters and off-pricers, Edelman doesn’t expect trading down to be a long-term trend. “After so many years of trading up, I think consumers will not be trading down in terms of quality,” he said. “They’ll buy less [instead].”
That means retailers will need to generate higher sales per square foot. The answer won’t lie in higher prices, but in better sell-throughs, Edelman advised. “It means better product, better value and lower markup.”