Apocalyptic dramatic background – giant tsunami waves, dark stormy sky
In the first four months of the year, nine major retailers have filed for bankruptcy protection, quickly surpassing the total five retailers that fell in 2022, a 13-year low, following 12 filings in 2021 and 35 in 2020, according to the latest BDO “Retail in the Red” report.
Besides the headline-grabbing bankruptcies of Bed Bath & Beyond
BBBY
And things are bound to get worse before they get better. Retailers face a perfect storm due to the rising cost of capital, trouble in the banking sector, slowing residential real estate market, record levels of household debt and persistent inflation that is already turning the tide on consumer demand.
The previously buoyant jobs market, which has remained on the plus side of the economy’s ledger, is showing signs of cooling, according to the Wall Street Journal. “The labor market looks to be normalizing, and the big question is whether it stops at ‘normal’ or charges right through it to the point of contraction,” said Luke Tilley, chief economist at Wilmington Trust Investment Advisors.
All of which clouds the forecast for retailers struggling to stay afloat. “It’s like a seesaw,” said David Berliner BDO partner, business restructuring and turnaround services.
“Retailers experienced an artificial increase from the pandemic and changes in consumer preferences coming out of COVID, like spending on home, casual dressing and less workwear and online shopping resulting in more costly returns. Now things are adjusting.”
“I don’t think it is going to be a bloodbath in retail, but if we are headed for a recession, that is when the snowball starts to go downhill and picks up speed,” he continued.
Naming Names
Increasingly, the question isn’t if a recession occurs but when. “I suspect that will be the story over the next 24 months,” shared James Gellert, chairman and CEO of Rapid Ratings International, a research and analytics firm that assesses the financial health of thousands of public and private companies worldwide.
“On the edge are highly leveraged retailers with debt that can’t be refinanced and are doing poorly operationally. That’s when we’ll see an uptick in bankruptcies,” he continued.
“Financial corporate health is a good deal like physical health,” he explained. “Healthy companies are in the best position to withstand a shock,” adding that his company’s ratings are measures of financial health and not credit ratings.
Mattress Firm and Wayfair are top on his list of retailers to watch, based on the company’s proprietary algorithm that provides two measures of a company’s financial health. These two companies are weak in both quantitative measures Rapid Ratings developed.
The Financial Health Rating (FHR) index, numbered from 0 to 100, provides a short-term view of a company’s estimated probability of default based on financial statements and leveraged against industry-specific models.
An FHR score under 40 indicates a company is at high risk for default, with a score from 0 to 19 at very high risk. Based on over 25 years of data collection and analysis, 91% of companies that filed for bankruptcy had an FHR signaling high or very high risk.
The Core Health Score (CHS) is a longer-term measure of a company’s overall health, measuring efficiency and competitiveness from an operational and structural perspective. Similarly, a CHS under 40 indicates poor underlying company health, with a CHS from 0 to 19 indicating very poor health. And the CHS value is also weighted to industry-specific measures.
Overall, the retailers included in Rapid Ratings’ database average an FHR score of 63.3, in the low-risk for default range, and a CHS score of 57.6, indicative of only medium health. But since 2021, both the industry’s FHR and CHS scores have risen, from 57.3 and 49 respectively.
However, some 14 companies fall well under the industry averages in short and longer-term health and are on Rapid Ratings’ watch list for potential default.
Home Retailers On Edge
In addition to Mattress Firm and Wayfair, at least four other home retailers may not have the resilience to adapt to the changing market dynamics.
Rapid Ratings FHR and CHS scores for home retailers
With more than 2,300 U.S. stores, Mattress Firm is 50% owned by Australia-based Steinhoff International, which announced it withdrew registration for a Mattress Firm IPO earlier this year.
Wayfair came off a particularly troubling year, with net revenue down 10.9% and active customers dropping 19% year-over-year. Despite generating $12.2 billion in net revenue, Wayfair losses mounted in 2022 to $1.3 billion.
Casper went private after being acquired by Durational Capital Management in late 2021 and remains on edge, as does Kirkland’s Home. It dropped 9% in comparable sales to $498.8 million and closed 16 stores last year while opening only one. Redbubble, with its marketplace for makers, Big Lots
BIG
Add to that list At Home Group, which went private in 2021 when private equity firm Hellman & Friedman acquired it. While Rapid Ratings doesn’t have data on the company, S&P Global just reported its credit rating has been downgraded from B- to CCC+.
All these home retailers enjoyed a boom during the pandemic when furniture store and home furnishings retailers got a nearly 20% boost in revenues from $120.6 billion in 2019 to $143.5 billion in 2022. But now the sector faces a consumer pullback in discretionary spending due to inflation, mounting credit card debt often used to finance major home purchases and a softening of the home market.
Once people’s homes have been updated and new furniture bought, they don’t need to go back to the well for more. And if they aren’t moving, a significant motivator for new home goods purchases, they don’t have any need at all.
Other Retailers In Question
The other retailers on Rapid Ratings’ watch list have either been profoundly impacted by post-pandemic changes in consumer behavior or have underlying issues with their business model, e.g., ThredUP and The RealReal.
Rapid Ratings’ FHR and CHS scores for other retailers on edge
The craft super-store Joann enjoyed a spike during COVID, which has now subsided. Net sales in fiscal 2023 declined by 8.3% to $2.2 billion, while SG&A expenses mounted 3.9%, and it’s still holding over half-billion in inventory. Losses reached $200 million and adjusted EBITDA dropped from $242.5 million last year to $98.5 million this. S&P Global also downgraded Joann credit rating from B- to CCC+.
TV shopping retailer iMedia Brands, with its flagship channel ShopHQ, has been treading water for years against behemoth Qurate Retail and its QVC
QVCA
But even Qurate Retail is facing headwinds, with its $12.1 revenues in 2022 down 14% from the previous year and an operating income loss of $2 billion. S&P Global downgraded its credit from B- to CCC+.
Food kit service retailers Marley Spoon and Blue Apron are also on edge as consumers look to economize against rising food costs and cutting the chord on fixed monthly expenses for subscription services. Plus HelloFresh is eating up more of the available food kit market.
The RealReal and ThredUP have filled the growing demand for previously-loved fashion, but profits have eluded both retailers bringing their business models into question. The costs of acquiring, managing and listing individual inventory items drags on the bottom line.
The RealReal trades in luxury with gross merchandise value of $1.8 billion in 2022, up 23% year-over-year, and total revenue of $603 million, up 29% over 2021. ThredUP garnered a 15% increase year-over-year to reach total revenues of $288.4 million. But both are underwater, with net losses attributed to common shareholders of $196.4 million and $92.3 million, respectively.
And rounding out Rapid Rating’s watch list is Lands’ End, a fashion retailer whose time may have come and gone. Fiscal 2022 revenues of $1.56 billion were down 5% and e-commerce revenues dropped 10%. Net loss totaled $12.5 million after reaching $33.4 million in 2021 and adjusted EBITDA was down to $70.5 million compared to $120.9 million in fiscal 2021.
Weak Links
Reflecting on the changes 2023 and 2024 will bring to retail, Berna Barshay, who left her full-time gig as editor and research analyst at Empire Financial Research to launch her own Substack financial blog under @HedgeFundGirl, said there has already been flushing out of weak retailers. And while many retailers will continue to be challenged, she doesn’t see a pile on of bankruptcy filings over the next 24 months.
However, the retailers that bear watching are the cohort of digitally-native e-commerce companies that filed IPOs in 2021, many with no history of profitability. “Too many of these companies took advantage of a frothy IPO market before they had a proven business model in hand. Some of them have never been profitable, nor have they given tangible evidence that their business models work.”
Besides ThredUP, Blue Apron and Rent The Runway, other newly minted public companies, notably Warby Parker and Allbirds, fall short in their Rapid Rating’s core health scores with CHS 22 and 17, respectively, while still holding the line on their short-term financial health, FHRs of 61 and 42. Rapid Ratings does not have data on Rent the Runway.
“Usually, these companies have war chests from their IPOs and late venture capital rounds, but they are burning through them,” she noted. “Market conditions, in both the public and private markets, are not hospitable to raising more money, so these companies will need to get profitable quickly,” as she pointed to Boxed as the canary in the coal mine for the 2021 IPO crowd.
Besides having an unproven business model, Barshay also observed these companies may be victims of optimism bias, believing their total addressable market is much bigger than it actually is.
“These businesses may be more niche than people thought they were,” she said. “If they were run as niche businesses, keeping overhead low and watching unit economics, they’d be okay. But investors put their money into these companies expecting to double, triple, even quadruple revenues. And the companies built an infrastructure to support that kind of growth which may not materialize,” she said.
These companies are also facing significantly increased marketing and customer acquisition costs now than they did a few years ago. Many can’t afford to downsize marketing fixed and variable expenses without revenues shrinking dramatically. One hope for nimble digital natives is how quickly they can open stores, since having a physical retail footprint is often their best advertising.
“It’s a cheaper way to acquire more loyal customers than digital marketing and real estate is getting cheaper while digital marketing is getting much more expensive,” she noted. But these companies will need capital open enough stores to make a meaningful difference.
And another complicating factor for retailers is keeping their vendors happy so that they keep shipping new stock to keep customers engaged.
“This is what happened to Bed Bath & Beyond. A retailer can’t get into trouble with its banks and bondholders without it carrying over to the vendors, who eventually won’t want to ship to you. Vendors are generally smaller than the retailers, and they can’t afford not to get paid once inventory leaves their warehouse,” she added.
Final Thoughts
It is still early days in 2023, but we can expect more retailer bankruptcy filings in the months ahead. The rate at which they fall depends on many factors, both inside and outside the company, but the economic environment doesn’t look good for retailers that didn’t shore up their businesses when the going was good back in 2021 and 2022.
“Today’s fast-paced consumer landscape demands speedy product delivery and easy accessibility, leaving traditional brick-and-mortar retailers struggling to compete,” Rapid Ratings’ Gellert said. “The current environment of inflation, high-interest rates, and limited access to capital only exacerbates the problem for highly-leveraged companies with large inventory loads and limited product diversity. These retailers, already burning through their cash reserves, are now at a greater risk of failure.
“Sadly, Bed Bath & Beyond, once hailed as an industry leader, is the latest example in a trend that will continue – once-dominant retail giants washed away by changing market dynamics,” he concluded.
See also:
Source: https://www.forbes.com/sites/pamdanziger/2023/05/03/perfect-storm-is-brewing-for-more-retail-bankruptcies-after-bed-bath–beyond-and-davids/