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BORROWED TIME

Retailers used debt to delay the inevitable and now time has run out

A Lord & Taylor store advertises a closing sale
Reuters/Brian Snyder
Tick tock.

As of Aug. 3, 43 publicly traded or large private retailers had filed for bankruptcy in the US in 2020, according to market intelligence firm S&P Global. It’s a rate not seen since the 2008 financial crisis and its aftermath.

The immediate cause, of course, is Covid-19, which has shut stores and reshaped consumer spending. But the main ingredients of the crisis—including unsustainable debt, one of the primary factors—were in place long before the new coronavirus appeared.

“A lot of the companies that find themselves in a distressed situation were eventually going to get there anyway,” Mickey Chadha, vice president and senior credit officer at credit-ratings agency Moody’s, said in an email. “They were just kicking the can down the road.”

They could do that because they had cash on hand, or they could borrow it, allowing them to cover their expenses and meet the interest payments on their debts. The last point is critical as many retailers have been propped up by shaky debt or carry large debt burdens, often left over from private-equity buyouts. If they don’t have enough cash to keep their operations going or have the bad luck of a big debt payment coming due, they can be forced into default.

The situation was less precarious prior to the pandemic, when Chadha said capital markets were still offering financing even to companies that might have been risky bets. “Now that these companies are under extreme stress, investors are reluctant to provide capital unless they are confident that the business is viable in the long term or that they can get a significant return for the risk,” he explained. More than two dozen retailers Moody’s covers had credit ratings it dubbed high risk or worse as of Aug. 3, including clothing company Land’s End, department store Belk, and pet products provider Petco.

Some companies haven’t even been making enough profit to cover the cost of interest on their debts. These so-called zombie companies have survived on financing, and they’ve been on the rise. Of the 1,085 publicly traded US retailers covered by financial data provider Factset, approximately 6% had profits below their interest costs in their latest completed year, up from 3.9% two years ago.

With many stores still not fully reopened and shoppers still buying fewer discretionary items, a number of companies have reported heavy losses. E-commerce generally hasn’t been able to offset the declines either. In the first quarter of 2020 it accounted for just 12% of US retail sales, and while that share has risen, it hasn’t made up for the lost sales from closed stores.  It also generally comes with higher expenses, meaning lower profit margins. Companies like Amazon, which has thrived during the pandemic by selling products such as groceries online, are more the exception than the rule.

Now back-to-school season has arrived and the holidays are approaching. Both are important for retail profits, but with Covid-19 cases rising around the US and so much uncertainty lingering about how it will play out, shoppers may still not get backing to spending like they used to. For many retailers, the situation is likely to get worse before it gets better.

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