Expect defaults of junk-rated retail debt to peak in March, before easing for the rest of the year, according to a new Moody’s Investors Service report.
The credit ratings agency said the retail and apparel sector saw 11 defaults in 2017, compared with seven in 2009 at the peak of the recession. It also said downgrades in credit ratings shot up 87 percent last year from 2016. And while the number of distressed firms — at “Caa1” and lower — are up, paving the way for more possible defaults ahead, the ratings agency said it expects speculative retail defaults to peak at 11 percent in March before dropping sharply to 5 percent in October. Moody’s also attributed the easing in defaults to retailers building out the required infrastructure to meet the shift to online, while reducing overall costs.
Moody’s said it believes the retail and apparel sector reached a “tipping point” last year, noting that those with leveraged balance sheets will find it difficult to compete in 2018. Price transparency, cutthroat pricing and a more demanding consumer translate into the need for strong balance sheets for retail and apparel firms that want to stay competitive. The ratings agency also noted that many retailers saw pronounced deterioration in margin because they spent heavily before the recession on building out their store base — resulting in a high fixed-cost structure. Many have shifted their dollars to invest in digital due to online growth, although the exceptions seem to be off-pricers and dollar stores, which still rely almost exclusively on brick-and-mortar customers.
The ratings firm estimated that apparel and footwear retailers would see square footage stay the same this year, compared with a 2.6 percent decline in 2017 and a 2.1 percent increase between 2007 and 2010. Specialty retailers are forecasted to cut their square footage in 2018 by 0.9 percent, compared with 1 percent growth last year and 3.9 percent growth between 2007 and 2010. Moody’s projected department stores will shrink their square footage the most, cutting 3.6 percent for the year, but also less than the 6.2 percent decline in 2017. Department stores as a group grew their square footage by 1.5 percent between 2007 and 2010. Off-price retailers are expected to increase their footprint by 3.7 percent, down from the 4.2 percent growth in 2017 and the 4.7 percent growth between 2007 and 2010. Further, Moody’s expects mall square footage to decline 3.7 percent as off-mall square footage growth rises by 0.8 percent.
Moody’s also said it expects retailers will be expensing their technology spend upfront, instead of capitalizing the costs and depreciating them in the future. It also noted that continued price wars and online competition will mean lower margins, and companies will need to ensure they have healthy balance sheets in order to continue to invest in growth and innovation.
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