Investor Panel Sees No End to Retailers' Struggles

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Chetan Bhandari has a simple test for determining whether to purchase a retailer’s syndicated loan, either for collateralized loan obligation or any other investment vehicle. 

“Would anyone miss this company if it went away?” said Bhandari, the managing director of Lazard Freres & Co., and until January a senior vice president and treasurer for Toys R US. “If the answer is no, then it’s a bad investment.

“I don’t think anyone is going to miss Rue21.”

Bhandari’s blunt assessment Wednesday at a CLO and leveraged loan industry confab in New York was harsh, but also in step with other pessimistic views among a panel of retail industry analysts and investors at the 6th annual conference, hosted by the Information Management Network.

Rue21, which filed for bankruptcy earlier this month, is among several department store and specialty retailers facing hard times in an environment in which sales declines, high leverage and competition from online retailers are pressuring many brick-and-mortar chains' ability to service their speculative-grade debt obligations.

The concern over retailers’ performance is particularly significant for current investors who face exposure to billions in debt from many over-leveraged chain stores like Sears, Macy’s, Nieman Marcus, Payless Shoesource and Gymboree, among dozens of others. Estimates are default rates in retail could reach 9% by year’s end.

“Retail is the worst performing sector in high yield,” and the only field delivering negative returns in the high yield bond and loan market, said Jenna Giannelli, a retail and gaming analyst for Citi, also on the panel. Many of these troubled firms are chains that would otherwise have a fair chance for survival but for the excessive leverage taken on in buyouts, she said, leaving them with 9x to 12x debt-to-EBITDA. “They don’t stand a chance.”  

Reporting such news brings her no joy. “It’s sad,” she said. “I lived in the mall 20 years ago.”

Dan Picciotto, senior director and analytics manager for S&P Global Ratings, said that other than discount retailers like Dollar General and Dollar Tree, a large universe of subsectors in retail are struggling badly.

Of 140 companies publicly rated by S&P, one-third have a negative outlook, 25% have junk ratings at B- or below, and “21% are in the C category,” said Picciotto. “We’ve been [issuing] more downgrades over upgrades for years,” he added, but the trend is “more pronounced” at this time.

“We ask ourselves, if there’s a [macroeconomic} hiccup, how much room is left for these companies at the lower end?”

In recent months, warning signals have been issued over retail exposures in CLOs.

In April, Fitch Ratings issued a report noting that while leveraged loan default rates remained benign, the agency raised concerns about looming defaults and bankruptcies of some speculative-grade rated retailers.

The surge of defaults expected in junk-grade alone is expected to raise the sector’s total institutional loan default rate to 9% by year’s end. That rate was at 0% prior to the April 5 bankruptcy filing of Payless Shoesource. Other loans of concern include Sears ($2.52 billion), Gymboree ($769.1 million) and Rue21 ($538 million).

But retail exposure is limited to just 0.6% of the 288 CLOs rated by Fitch.

Earlier this year, Nomura reported 20% of retail loans in CLOs are priced below 90 cents on the dollar in the secondary market. Morgan Staney noted that 24% of retail loan are considered “distressed” and account for a fifth of distressed collateral in U.S. post-crisis CLOs.

What many of these companies have in common is a lack of online presence and failing to deliver in the niche sector they pursued, said Goldman Sachs’ managing director Grady Frank. “There are a lot of secular headwinds against apparel,” Frank said.

From his panel seat, Frank used an example of a client trying to rectify its online market gap: Petsmart. The retailer acquired online rival for $3.35 billion in a bid to diversify its reach online, and has issued $2 billion in a privately placed senior note financing to help pay for the acquisition.

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