FEDERATED SHARES IN SHARP DROP, FINGERHUT CREDIT ILLS BLAMED
Byline: Jennifer Weitzman
NEW YORK — Shares of Federated Department Stores tumbled 12.6 percent to their lowest mark in five years, as the company said it expects earnings to take a hit directly resulting from $400 million in potential credit delinquencies at its Fingerhut subsidiary.
The company, which is parent of Macy’s and Bloomingdale’s as well as a host of other department stores, said the impact from the credit problems at its Fingerhut catalog unit might cut fiscal second-quarter earnings by $150 million, or 43 cents a diluted share.
James M. Zimmerman, Federated’s chairman and chief executive officer, said the company is taking numerous steps to address the credit delinquency situation at Fingerhut, but said it will take time to rectify the problem and alleviate its impact on earnings.
The Cincinnati-based retailer first told Wall Street analysts about the potential problem three weeks ago when it reported its June sales results.
At that time, Wayne Hood of Prudential Securities estimated Federated earnings to be dragged down about $27 million, or 13 cents a share, if the delinquency trends were to move to their 1996-1997 levels.
Shares of Federated closed down 3 3/8 to 23 1/2, marking the second straight day in which it established a new 52-week low on the New York Stock Exchange. One year ago this past Wednesday, it reached its 52-week high of 56 9/16.
Zimmerman said in a statement that the company will require increased reserves for bad debt to alleviate the credit problem. In addition, the company said it expected lower catalog sales will potentially lower earnings before interest and taxes in the direct-to-customer segment by an additional $200 million to $250 million in the fall season.
“We are making numerous changes that we believe will have a significant, positive impact on future credit profitability, although we expect these changes will negatively impact mail-order catalog sales in the short term,” Zimmerman said.
Zimmerman also emphasized that this situation “does not reflect on the performance of our department stores, which, despite recent weakness in apparel sales, remain strong.”
Michael Exstein, with CS First Boston, said he was disappointed by today’s results. “For the past nine years, Federated has taken pride in its ability to operate, control and deliver results. Clearly, the announcement has damaged this stature.”
“We are taking this situation very seriously,” said Zimmerman. “We believe we understand the problem, we know what caused it, and we are aggressively taking steps to fix it.”
Federated purchased Fingerhut, a catalog and Internet company, last February for $1.7 billion to jump-start the retailer’s direct-to-customer sales business, a move Wall Street found surprising, but inspired because Minneapolis-based Fingerhut gave Federated both an Internet presence and fulfillment capabilities for the first time. It also broadened its price spectrum by returning it to lower-moderate and budget prices, which are featured in Fingerhut’s 25 catalog brands. However, Fingerhut’s dependence on lower and middle-income consumers exposed it to the credit vulnerability in the current climate, in which higher fuel prices have begun to erode some spending power.
Years ago, Federated abandoned the lower-price and budget markets by discontinuing its Gold Circle and Main Street discount divisions, and by shutting the basement operations in many of its department stores, including Bloomingdale’s.
When the deal with Fingerhut was announced, Zimmerman stated, “This is certainly a bolder or different kind of move than buying a Mercantile or Broadway Stores.” Fingerhut’s problems stem from the conversion from closed-end installment to revolving credit, implementation of late fees, aggressive deferred-credit offerings for newer customers and worsening economic conditions.
To add to Federated’s woes, shares fell 17 percent on July 6 after the company reported disappointing June sales and same-store sales.
Same-store sales grew a slower-than-expected 0.5 percent, compared to a jump of 8.4 percent in June 1999. June comps reflect a general slowdown at Federated over the past two months as May and April’s comps were up 4.2 percent and 5.2 percent, respectively.
To help buck the trend of increasing delinquencies, Ronald W. Tysoe, Federated vice chairman, said the company has moved responsibility for Fingerhut credit operations to Federated’s Financial and Credit Services Group, where it now reports to the group’s chairman and chief executive, James J. Amann.
In addition, Federated said it will increase collection activity, lower credit lines and tighten initial granting of credit, introduce new credit-scoring criteria for moving credit lines up or down, initiate aggressive address verification practices for new accounts, reduce deferred credit offering and introduce a minimum-purchase requirement for deferred credit, as well as revise billing statements to highlight Fingerhut’s name.
Rosemary Sisson, a director with UBS Warburg, said the total amount of bad credit was much higher than the $200 million expected on $2 billion of receivables.
Sisson said she didn’t think Federated would announce any more delinquencies because she felt its management did a good job of candidly explaining the problem.
“They are trying to be careful not to find more dirt under the rug,” Sisson said. “It looks like they will be able to turn business around in 2001. They run a great department store and are disappointed in themselves.”
She said she expects the company’s sales to drop, but profits to increase as it takes a more conservative approach to extending credit.
Although she said purchasing Fingerhut was “not a bad decision,” she believes Federated should have sold the credit operation because “they don’t need it.” Management simply focused on the fulfillment operation and left the credit operation alone, probably because they were profitable for a long time, she said.
Margaret A. Gilliam, president of Gilliam & Co., said she thought that Federated’s acquisition of Fingerhut was “brilliant,” but she said the company “raised red flags” when it announced in April that it had converted most of Fingerhut’s accounts to revolving from installment credit. “Fingerhut had a good thing going: It charged high prices and gave credit to people who might not have it otherwise,” she said.
She added she expects more bad credit to be revealed further down the line because Federated said on its conference call that the company is raising its reserves to $700 million from $317 million for bad debt.
“They had a formula that worked for its customer, who tends to have a lower income, and Federated started to meddle with it by lowering prices and relaxing its standard for deferred billing. It has come back to haunt them,” Gilliam said.
“In essence, Federated is making Fingerhut more like Federated, and what [Fingerhut] used to have worked.”