RETAIL DEBT RATINGS ERODE
Byline: Sidney Rutberg
NEW YORK — Average credit quality in the retail industry has been deteriorating steadily since 1992, according to a study by Moody’s Investors Service of 113 publicly owned retailers.
In the past five years, the average debt rating of the group has dropped from Baa3, a strong investment grade rating, to Ba3, which is below investment grade, but considered upper-speculative grade.
However, Richard Mercier, Moody’s lead analyst on the study, said part of the reason for the decline has been the changing universe over the past five years.
“A number of smaller, newer companies were rated in the Nineties that had not been part of the universe before,” he said. “May Department Stores, for example has maintained its strong rating for years. At the other end, County Seat, which is now in bankruptcy, wasn’t rated in 1992.”
And going forward, Mercier said, the stronger retailers will get stronger and the weak will fall by the wayside. “Retailers with strong finances and the ability to execute will survive in a difficult environment,” he said.
The study notes that the industry will face low growth, low inflation and uncertain consumer spending.
Moody’s also expects consumer credit problems to continue.
“During the last few years,” said Moody’s in the 110-page study, “slow economic growth, modest disposable personal income growth and high consumer debt burdens have constrained consumer spending.
While growth in the unemployment rolls has slowed from the pace exhibited between late 1994 amd early 1966, years of corporate downsizing and layoffs have left consumers less certain about their own employment outlook.”
Moody’s also notes that while consumer debt service costs may have peaked, “it is unlikely that a decrease in these numbers will transfer to increased consumer spending until late 1997.”
During the second and third quarters, debt service stood at just under 17 percent of disposable income.
The study covers discount stores, department stores and apparel specialty stores, along with supermarkets and category killers.
In the discount group, Wal-Mart is on top of the list with the best credit rating (Aa1 and Aa2), reflecting its strong financial flexibility, its low cost structure and expected improvement in returns.
Wal-Mart’s cost structure is far below that of other major discounters. Wal-Mart costs are at 16 percent of sales compared with nearly 23 percent at Kmart.
Gross margins at Wal-Mart have been running at just over 20 percent from 1992 through 1995, leaving a comfortable 4 percent between costs and gross margins for net profit.
During the same period at Kmart, gross margins have slipped from just under 26 percent in 1991 to about 24 percent, just a scant one percentage point above costs.
Kmart’s rating has gone from A1 in 1992 to Ba3 in May of l996. Currently, Moody’s says Kmart’s rating outlook is stable and the investors service expects “slow but steady progress in improving its financial performance.”
Gross margins in the department store group have declined to 32.7 percent in 1995 from 33.7 percent in 1992, as a result of increased promotions. At the same time, department stores as a group have cut their selling, general and administrative costs to 25.9 percent of sales in l995 from 27.5 percent in 1991.
Among the department store groups, Mercantile Stores Co. has the highest rating, A1, supported by its “conservative financial management.”
J.C. Penney Co. also has an A1 rating, but it is under review for a possible downgrade. May Department Stores and Sears, Roebuck & Co. are rated A2, with the other major retailer, Federated Department Stores, rated Ba1, but in a position for a higher rating once it completes the spending involved with the Macy’s and Broadway Stores acquisitions.
Dillard Department Stores is “comfortably positioned in the A2 rating category.”
In the specialty store category, The Limited had its rating cut to Baa2 in January from A2 because of its restructuring program.
While the company has a good record for developing new concepts, “it has still to show that it can successfully manage its more mature concepts on a consistent basis.”
Gap has no rated long-term debt, but its commercial paper is rated prime 1, the top rating. Moody’s notes that “superior merchandising and management controls mitigate to some extent the volatility to which specialty apparel stores are subject.”