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The squeeze is on, and it’s getting tighter.
This story first appeared in the September 17, 2008 issue of WWD. Subscribe Today.
Already miserly lenders — laid low by a yearlong mortgage-related credit crunch — are retrenching yet again this week in the wake of Lehman Brothers’ bankruptcy, a deal to sell Merrill Lynch and a reordering of the banking landscape.
The financial instability is prompting fears that the credit crunch could spread, perhaps further limiting consumers’ access to credit, and is casting a dark cloud over the already flagging U.S. economy as retailers head into the make-or-break holiday season.
More immediately, the sweeping changes on Wall Street promise to make financing even more expensive for fashion’s stronger companies and the position of the industry’s marginal players all the more tenuous.
“I don’t know how long it’s going to remain negative, but I think the [lending] markets are going to be jittery now, waiting for another shoe to drop,” said Ed Henderson, vice president and senior analyst at the debt rating agency Moody’s Investors Service. “Financing is definitely tougher. I think people will avoid the markets to the extent they can.”
Henderson, who covers the larger department store chains, said some forms of short-term loans in what are known as the commercial paper markets were available, but at higher interest rates and for a shorter term.
“The markets are going to be tougher to access for the next short period of time than they were a week ago,” said Henderson, who said lenders would remain cautious until things calm down. “You need a period of time without some big headline about a big financial institution that’s in trouble.”
After the Dow Jones Industrial Average plunged more than 500 points on Monday, U.S. markets moved upward and downward on Tuesday as news developments dictated. The Dow finished ahead 141.51 points, or 1.3 percent, but at one point early in the session was off nearly 163 points on concerns about American Insurance Group’s solvency. Following the first rebound, the index lost ground in the early afternoon after the Federal Reserve decided to leave interest rates unchanged, only to recover again in the final hour of the trading day.
The Standard & Poor’s Retail Index followed a similar trajectory, but finished the day with a 0.8 percent increase, just below the 400-point mark at 399.41.
Specialty retailers — those geared to teens as well as the more mature — regained lost ground during the session. In addition to Buckle — which unveiled a stock split and a special dividend and saw its shares move up 3.8 percent — youth retailers with gains of 3 percent or more included Zumiez (5.6 percent), Aéropostale (5 percent) and Pacific Sunwear (4 percent). Misses retailers exceeding that mark included Cato (6.3 percent), Chico’s FAS (5.1 percent) and Christopher & Banks (5 percent). Eddie Bauer, which has seen its shares appreciate strongly in recent weeks, was down 4 percent.
Dillard’s shares moved up 6.5 percent, while Retail Ventures and Macy’s advanced 3.9 and 3.7 percent, respectively. In the value market, Target was ahead 4.5 percent and Stein Mart, 4 percent. Wal-Mart was down 0.8 percent during the session.
Lululemon Athletica enjoyed a 7.7 percent spike, while Movado and Kenneth Cole Productions were up 4.9 percent and 3.1 percent, respectively.
Investors in Tokyo took the lead from the U.S. markets’ drop on Monday and pushed shares in the Nikkei 225 down 5 percent, or 605.04 points, to 11,609.72 Tuesday. Among the fashion decliners in Tokyo were Fast Retailing, which runs the Uniqlo chain and was down 5.9 percent to 10,740 yen, and Shiseido, which fell 1.5 percent to 2,565 yen.
Most Asian exchanges were on the sidelines Monday, closed for public holidays and not able to react to the weekend’s news until Tuesday.
European markets continued their path downward on Tuesday, as well. On the London Stock Exchange, the FTSE 100 fell 2.3 percent, making for a two-day drop of 6.2 percent. Among those losing ground for the day were Burberry Group, down 0.5 percent, and Marks & Spencer, 2.6 percent. Gainers included Asos, up 4.8 percent, and French Connection, 7 percent.
Across the English Channel, the French CAC-40 index was down 2 percent, but Hermès International saw its shares pick up 9 percent. LVMH Moët Hennessy Louis Vuitton gained 0.1 percent and L’Oréal was up 0.6 percent. Carrefour declined 1.3 percent on the day, while Gucci parent PPR was down less than 0.1 percent. In Milan, Bulgari enjoyed a 2.4 percent gain and Luxottica Group and Safilo Group saw increases of 1.1 percent and 0.5 percent, respectively. Decliners included IT Holding (2.4 percent), Tod’s (1.3 percent) and Benetton Group (0.4 percent). In Stockholm, Hennes & Mauritz was off 1.3 percent on the day, while Inditex Group locked in a 3 percent increase in Madrid.
Matt Katz, managing director at Alix Partners LLC, a restructuring and advisory firm, said the Wall Street shake-up was dramatic enough to reach the average consumer.
“This makes this absolutely real to them,” he said. “We glorify the financial institutions in the press, we glorify them in movies. It’s an aspirational business. There’s a story there and the public responds to stories more than they respond to data, and so now you’ve got very real concerns.”
And the financial world’s woes might next come to the average consumer.
“A next potentially large fear is what happens to the individual’s credit,” said Katz. “Just as there were real estate brokers who went out to pitch new mortgages to individuals, there were 10 times as many credit card offerings.”
In July, credit held by consumers rose at an annual rate of 2.1 percent, a slowdown from June’s growth rate of 5.1 percent, according to the most recent figures from the Federal Reserve. The month-to-month deceleration was attributable to the slower growth of so-called nonrevolving credit, which includes loans for cars and education. Of the more than $2.5 trillion of outstanding consumer credit in July, commercial banks held $820.5 billion, while finance companies carried $586 billion and credit unions accounted for $236.6 billion.
Even before the latest round of doom-and-gloom headlines from the financial sector, consumer confidence had hit historic lows, even despite a recent upswing. The University of Michigan’s consumer sentiment index, released Friday, rose to 73.1 for September from 63 in August.
The pickup in sentiment was likely due to the recent sharp pullback in gasoline prices, but not a sign consumer spending will improve later this year, said John Ryding, economist at RDQ Economics.
“We expect consumers to pull back under the weight of rising unemployment, falling incomes and weak asset prices,” Ryding said.
This latest financing shock comes on top of a credit crunch that already has helped push some retailers, including Mervyns and Boscov’s, into bankruptcy and pushed many others into a protective stance.
Matters are only exasperated by higher raw material, fuel and labor costs around the world that are squeezing producers.
“The renewal or refinancing of existing asset-based deals is going to become much tougher,” said Antony Karabus, chief executive officer of Karabus Management, a Toronto-based finance and operations consultancy. “Access to capital will practically be a matter of survival of the fittest. Retailers tell me their payables departments are a lot busier with calls from vendors, who’ve found borrowing exponentially more difficult in the last few months.”
Solid retailers with strong balance sheets, brands and able management teams should continue to fare pretty well, though lining up some types of financing could become more expensive.
“But a lot of the weaker players, especially those who are heavily leveraged, are going to find the going much more difficult,” said Karabus.
Specifically, he said companies are going to have to make sure they can cover their interest payments and, if business has slowed since that last round of financing, new borrowings would come with more strings attached.
“Covenants are going to get tougher because the banks are pressuring the stores to clean up their balance sheets,” he said. “The question becomes, in a climate of declining sales, how can I best manage my [earnings before interest, taxes, depreciation and amortization]? There are really only four levers — sales, margin, [selling, general and administrative expenses] and capital expenditures.”
Retailers have to worry not just about their own fiscal health, but their shoppers’ finances, as well. And trouble among the financial set is never good for retail.
“There has to be some impact with the layoffs and lack of bonuses for a community that has been very supportive of the retail sector,” said Marvin Traub, president of his namesake consulting firm. “It’s the financial sector and the real estate sector at the moment, but those are important sectors on the economy.”
Although the exact impact of the turmoil is hard to know, Traub said it would take some luster out of the holiday season.
“One has to watch the business day by day,” he said. “I would be planning very hard about how I can get business from my competitors from now through Christmas.”
Total retail sales, excluding motor vehicles and gasoline, should rise 2.5 to 3 percent in the November-to-January period, with a comparable-store performance of flat to 1 percent ahead, making for a very challenging season, said Carl Steidtmann, chief economist with Deloitte Research. That’s less than last year’s 3.4 percent increase, and one of the smallest gains since 1991’s 2 percent uptick.
Steidtmann said the Wall Street events this week are difficult to factor into the forecasting, but that the impact would be relatively small.
“Most of the job loss will be in New York, affecting retailers generally in the greater New York area,” he said. “But the other side of this is that, in the last week or so, we have seen a sharp decline in oil prices that will translate into lower prices [at the pump] and lower heating prices.”
Stacy Janiak, Deloitte’s U.S. retail leader, added that retailers appear to be positioned well heading into the holiday season, with low inventory-to-sales ratios and payrolls and other costs that are in check, to offset the extensive promotions expected to be unleashed for the season.
Cutbacks can be found even at luxe shopping outposts.
“We are always looking to trim,” said Ron Frasch, president and chief merchandising officer at Saks Fifth Avenue. “We have been doing this long before the current situation. Initially, it was much more relative to the euro and the cost of travel, but we are being very tight with our travel expense for sure.”
He estimated that about 35 Saks people will be in Europe for the upcoming shows in Milan and Paris, but not all at once.
Ken Downing, senior vice president and fashion director at Neiman Marcus, said the retailer is sending fewer people to Europe.
“I feel we’re a little of an abbreviated group than we’ve been in the past,” said Downing. “As the fiscally responsible organization that we are, we are making sure we’re bringing the people that are needed and looking at those costs right now.”
However, while the events on Wall Street this week were frightening, sending reverberations around the world, retailers, at least in the near term, will be reacting more emotionally than tangibly. That’s because through this year, already many have been planning conservatively, cutting back on renovations and expansions, closing doors and working to adjust to the weakening sales climate and poor economy.
Even with this week’s triple-barreled crisis and “the magnitude of the 500-point Dow meltdown,” Arnold Aronson, managing director of retail strategies at Kurt Salmon Associates, stated, “retailers are not going to get caught in a whipsaw. Most retailers have already set new standards and strategies to cope with a down economy. A one-day performance of the stock market is not necessarily going to seriously change those strategies.”
Most retailers will continue to plan conservatively until there is solid evidence of a recovery, he said.
“Certainly, the election and the ensuing hundred days of presidential and congressional action will begin to reset the economic environment,” said Aronson.
The banking disruptions have made the chances of a renewal in merger and acquisition activity slimmer, however.
“There are always deals to be done in any market. But when change comes so rapidly, it creates not opportunity, but paralysis,” said Richard Kestenbaum, a partner at investment banking firm Triangle Capital LLC. “Time needs to pass for people to adjust to the change as if it happened over a long period of time. That’s when deals start to get done.”
Kestenbaum’s firm has been busy this year, working on deals at opposite ends of the spectrum, from companies doing extremely well to those that are struggling and in need of a partner. As for firms such as NexCen Brands, which is looking to sell Bill Blass, Kestenbaum said the environment makes it “neither easier nor harder” to dispose of the designer business. What it does do is make the asset “less valuable” because there are fewer alternatives that are open to the seller.