Jan. 2, 2009.
This story first appeared in the September 19, 2008 issue of WWD. Subscribe Today.
That will be a key day for retailers, who by that time will either be celebrating, scraping through one of the toughest holiday seasons in two decades or else rapidly rewriting their business plans for the New Year to further scale back on expansion and other capital expenditures.
As Wall Street perked up Thursday, jumping 410 points, industry observers continued to scramble for some signal as to what lies ahead. While uncertainty remains the theme, most analysts agreed that difficult times will persist for months.
Wall Street bounced back in late afternoon trading following a report the federal government would create a repository for the bad debt of banks in the hope of easing some pressure and opening up the credit markets again.
Retail stocks benefited from the reports of a new entity to address the staggering pile of bad debt, making up about two-thirds of Wednesday’s losses. The Standard & Poor’s Retail Index gained 16.60 points, or 4.4 percent, to end the day at 390.38.
Treasury Secretary Henry Paulson Jr. was reported by numerous sources to be considering an entity similar to the Resolution Trust Corp. formed in the Eighties to cope with the financial stress brought on by the savings and loan collapse. In the current scenario, the RTC-like entity would likely acquire real estate debt and help financial institutions shed it from their balance sheets. Earlier in the day, the markets were buoyed when the world’s largest central banks said they’d inject about $247 billion in liquidity into the global financial system. That led to gains in the European markets, which in turn set the stage for a higher opening on the U.S. front.
While the news of the repository idea and the central bank infusion lifted markets, they hardly dispelled the many doubts that have arisen over the course of the last week about the impact of the spiraling credit crisis on consumer spending.
“Mentally, your average Mr. and Mrs. America may still feel afraid to spend, and may decide to put their money in a bottom drawer and not spend it,” said Bob Carbonell, the chief credit officer at Bernard Sands, a credit-checking firm. “If they don’t spend, Christmas 2008 will not materialize. If that happens, a lot of retailers will have some decisions to make come Jan. 2 on what they’re going to do.”
Despite the potential for insolvencies at retail and elsewhere, for the moment Carbonell isn’t updating his credit watch list. “They’ve all filed,” he said about the stores that were already on that list.
“A lot of this is without precedent,” he added. “The volatility has been horrible and no one knows how much longer it will go on. A lot of this stock activity is emotional.”
Given the extent of the market volatility this week, plenty of uncertainty remains.
“The way this affects retail is what it does to consumer confidence, as well as its impact on the ability of retailers to get credit,” said Jim Rice, a senior credit analyst at F&D Reports Creditintel. “Holiday was predicted to be soft anyway. But with a couple of months to go, maybe the outcome of the election may change people’s moods.
“You never know what could happen,” he concluded, summing up the feelings of many about the events of the week.
James Schaye, president and chief executive officer of Hudson Capital Partners LLC, a liquidator, sees more store closures, but not immediately and probably nothing significant ahead.
“I don’t expect anything between now and the first of the year, at least not on a substantial basis. We’ll see a significant amount of store closures after the beginning of the year though. That’s when banks will look at sales figures and the value of the assets of the retailer, and make some determination on what the risk is to the banks’ own portfolios,” Schaye said.
Retailers seemingly already pressured are the bankrupt Linens-N-Things, and many regional players, such as Bon-Ton Stores Inc. and Gottschalks Inc., could see more trouble ahead as consumers pull back on their spending.
Should consumers become even more spooked and not spend as much as anticipated for the holidays, retailers would be forced to slash their prices to move inventory.
“If they mark it down, then their margins are going to narrow and they’ll probably have less [earnings before interest, taxes, depreciation and amortization] than they would otherwise and that has the potential for creating a problem,” Gerald Hirschberg, Standard & Poor’s debt analyst, said. “If EBITDA is narrower than expected, then some of them could be bumping up against a financial covenant. The banks may be somewhat less willing to offer amendments to these companies or if they do the fees that they charge will be possibly higher.”
Retailers and vendors in many cases promise to maintain certain EBITDA levels as a condition, or covenant, of bank loans used to operate their businesses.
Although the retail sector appears on the surface to have limited exposure to the financial firms making headlines, such as Lehman Brothers, the conditions fueling the financial meltdown are pressuring fashion as well.
“There are more companies today that are perhaps closer to a default than we had previously,” said Hirschberg.
The industry has been at least partially prepared for tough times. The gathering consumer storm prompted stores to spend most of the year tightly controlling inventories, reducing future orders and cutting expenses. Additionally, major stores have cut back on store opening plans and capital expenditures in general. Further cuts may still be necessary, however, if the already sober holiday outlook deteriorates further.
Piper Jaffray retail analyst Neely Tamminga not only anticipates that retailers will further scale back plans for new stores, but she also expects them to close existing units. Women’s specialty apparel retailers might largely avoid the need to shutter stores, she said, because they have already gone through an “early recession.” The Talbots Inc., AnnTaylor Stores Corp. and Charming Shoppes Inc. have already cut back considerably, and J.C. Penney Co. Inc. has scaled back expansion plans for next year.
On Thursday, Tamminga downgraded Ann Taylor’s stock to “sell” from “neutral,” saying that “investor appetite for consumer discretionary stocks is increasing despite eroding fundamentals in retailing.” Ann Taylor and other early-cycle recovery stocks might look better than they are, she said.
“What we’re seeing is unprecedented,” said B. Riley & Company Inc. retail analyst Jeff Van Sinderen, in reaction to the swings in the stock market. There has been a very “immediate” psychological impact from the Wall Street contraction, which not only affects consumer spending, but also investing, he said.
“It’s extremely hard for retailers to get credit,” he said. “Even a week ago, it was easier.”
Continued scale backs on expansion plans are “inevitable,” he said. “It doesn’t make any sense for retailers to wait and see what the holiday is like. The question isn’t if things are going to get better. The question is how bad is the holiday going to be.”
“We’ve seen lending standards tightening at an unprecedented pace,” Ben Garber, economist at Moody’s Investors Service, said. “The lending base is shrinking so it’s a very difficult environment for business expansions. We’ve got the slowest rate of consumer spending growth in about 17 years; the outlook for apparel retailers is not particularly good at the moment. We’re shedding jobs at a recessionary pace, so the fundamentals for strong retail sales are not there.”
The U.S. has had eight straight months of job declines, with 84,000 positions lost in August alone. The unemployment rate rose to 6.1 percent last month, up from 4.9 percent in January.
Garber said unemployment would peak and housing prices would probably bottom out during the third quarter of next year, marking the beginning of a turn for the consumer.
More immediately, there’s still holiday 2008 for retailers to worry about. TNS Retail Forward forecasts holiday sales will be the weakest in 17 years. It is forecasting 1.5 percent growth, compared with a 2.7 percent gain in 2007 and 1.2 percent in 1991.
While TNS said mass retailers will see a pickup in performance this holiday as shoppers shift their focus toward value formats, sales at apparel and accessories channels are expected to decline 1.3 percent during the holiday period, compared with flat growth in 2007. “Department stores, including the upscale players, will remain the biggest drag as upper-income households become increasingly vulnerable to economic pressures,” TNS predicted.
Fitch Ratings, a credit ratings agency, said, “U.S. retail sales for the winter 2008 holiday period are expected to be weak while economic pressures continue to strain consumers’ cash flow.”
Fitch analyst Karen Ghaffari, who heads up the rating firm’s U.S. retail group, said, “Consumers are focusing on the necessities and getting more ‘bang for their buck,’ which has benefited discounters such as Wal-Mart and Costco Wholesale.”
Fitch said it expects “many U.S. retail issue ratings to remain at current levels” but added that there is a “downside rating risk especially for high-yield companies operating in the discretionary department store and specialty retail sectors….A retailer’s ability to sustain operating performance in-line with peers as well as its willingness to maintain a strong balance sheet to ensure adequate liquidity will be crucial to future rating actions.”
But at least for a day, the RTC concept allayed market fears. Among many taking a positive view of it was Andrew Moser, co-founder of the Kairos Capital Partners hybrid fund.
“Any time you can pull assets like that and bring an organized resolution over time to liquidate and generate the highest recovery possible is good,” he said. “And this is a generally good way to do that because you will also be bringing into play strong industry expertise where the focus is on maximizing value and assets.”
However, Moser, who has spent a considerable amount of his career in asset-based lending and asset dispositions, believes there still will be more shakeouts to come. He added the news Wednesday that New York State Attorney General Andrew Cuomo was investigating the practice of short selling stocks, or essentially betting on them to go down, will also help calm the marketplace.
“What’s really behind that issue is the inflated values that we’ve been living with. No one knows what the value of anything is anymore, and that’s the main issue on Wall Street now,” he said.
Moser expects investors will be in a defensive mode for at least the next several months and into early next year. “The good news is that the upcoming presidential election is less than 50 days away. Whoever emerges [as President] will come out with a fresh outlook and provide some greater confidence. There has been so much uncertainty piled on top of uncertainty,” he said.
It is still too early to tell when an RTC-like plan could be implemented. One financial source said even if such an entity were in place, it could still take 10 years to fully recover from the subprime debacle.
U.S. stocks sharing in Thursday’s sense of relief included Charming Shoppes (up 15.9 percent) and Pacific Sunwear of California Inc., whose 14.2 percent advance more than eradicated the 11.1 percent decline registered Wednesday. J. Crew Group Inc. registered an 11 percent pickup and, on the broad lines side, Saks Inc. and Macy’s Inc. advanced 10.8 and 7.3 percent, respectively. Kohl’s Corp., downgraded to “hold” from “buy” by Citigroup broad lines analyst Deborah Weinswig Wednesday night on valuation concerns, managed a 4.3 percent increase, while J.C. Penney was up 5.1 percent. Outstanding among wholesalers were Volcom Inc. (up 15 percent) and Liz Claiborne Inc. (up 13.3 percent).
On the Tokyo Stock Exchange, where the Nikkei 225 fell 2.2 percent to 11,489.30, some fashion firms lost considerable ground, with Shiseido down 4.6 percent, Fast Retailing off 4.5 percent and Link Theory, 3 percent lower.
In London, the FTSE 100 inched down 0.7 percent to 4,880.00, as Marks and Spencer Group plc managed a 2.3 percent upswing and shares of Burberry Group rose 3.6 percent, each rebounding from declines from the day before.
Other European fashion companies staging a rally included Hermès (up 2.6 percent), Luxottica Group (1.6 percent), L’Oréal (2.5 percent), Hennes & Mauritz (1.5 percent) and PPR (0.5 percent). Among the decliners were Tod’s (down 1.8 percent), LVMH Moët Hennessy Louis Vuitton (1.3 percent) and Inditex (0.8 percent).