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Even though consumer spending, the labor market, and GDP growth remain healthy, there are risks that could put coal in distressed companies' stockings this holiday season, analysts at credit rating agencies say.

Why it matters: November and December are when retailers replenish the cash on their balance sheets — a buttress most will need to weather growing headwinds clouding 2024's outlook, Richard writes.

What's happening: "The consumer will continue to spend," Fitch Ratings retail analyst David Silverman tells Richard.

"The one thing that's been a bedrock is unemployment," S&P retail analyst Sarah Wyeth concurs.

Distressed issuers will also benefit from tapering inflation and reduced costs, resulting in improved margins, Silverman says.

Freight costs, specifically the price of shipping containers, have decreased precipitously, Moody's retail analyst Christina Boni notes.

Plus, retailers are getting better at managing their supply chains and finding new revenue streams from retail media networks and marketplaces, Moody's retail analyst Raya Sokolyanska says.

Yes, but: Among the challenges are the resumption of student loan payments, geopolitical risks posed by wars in Ukraine and Israel, political dysfunction in the U.S. that could lead to a government shutdown, and a continued rise in interest rates.

Elevated default activity over the next two years will be driven by a combination of liquidity challenges and refinancing risk as debt maturities loom, Silverman says.

"We should be concerned about the number of companies that are overextended and have shortening fuse lines," says RapidRatings CEO James Gellert, who suspects 2024 could be a robust year for bankruptcies.

Between the lines: Consumers are also shifting spending from discretionary to experiences such as travel, entertainment, dining and sports, Silverman says.

"The consumer continues to hang in there in terms of aggregate spending. Where weakness shows up is in how they're spending," Wyeth says.

In particular, spending on home appliances and furniture has declined after getting a boost during the pandemic, while apparel is also taking a hit, Sokolyanska says.

Given those shifts, that means that companies in the entertainment and leisure categories are going to benefit more than others.

What we're watching: In all, some 52 issuers in the consumer and retail sectors are rated either CCC+ or Caa1 or below by the major rating agencies, including S&P and Moody's.

Other companies that are on the cusp of being distressed, either rated B3 or B- with negative outlooks, include Conair, Olaplex, Whole Earth Brands and PDC Wellness & Personal Care.

Gibson Brands, Rugs USA, Guitar Center, and Mountaineer Merger Corp., which does business as Gabe's, are also in that mix.

Then some companies fall outside the rating agencies' purview.

Retailers at the top of financial health analytics provider RapidRatings' watchlist include online furniture retailer Wayfair, meal delivery provider Marley Spoon, mattress brand Caspar, and value-oriented retailer Kohl's.

1 big thing: A short-lived holiday reprieve

an illustration of a cart tipping over and dumping out a bunch of red warning signs 

Troubled retailers aren't in the clear this holiday season as those burdened with a heavy debt load could find it too difficult to reverse.

Why it's the BFD: The more expensive financing environment is unlikely to improve the situation for those in distress, Kimberly writes.

What's happening: "While the availability of the financing is there, the ability to service the financing is more difficult," Perry Mandarino, senior managing director and head of restructuring at B. Riley Securities, tells Kimberly.

A loan could have cost a borrower 4% to 6% two years ago. Now, it's more like 9% to 11%, he says.

Interest rates will likely remain elevated over the coming months, says David Berliner, a principal at BDO's restructuring and turnaround services practice.

"We're going to see added borrowing costs and what that does is it limits your ability to refresh your stores and spend money on initiatives," he adds.

Zoom in: Most of the retailers that went south this year didn't have a particularly strong e-commerce presence, Berliner says. (Rite Aid and Bed Bath & Beyond both struggled in this regard).

If stores look old and sluggish and the shelves are empty or messy, "you don't get a lot of repeat business that way," he adds.

If retailers don't perform well this holiday season, then their lenders' and their vendors' support is going to erode, "making it harder and harder."

Between the lines: The most successful retailers have less debt, Mandarino says.

Flashback: Retail LBOs — a strategy predicated on the ability to open stores — were more successful when economic cycles were more regular and predictable, and e-commerce wasn't stealing as much market share.

The big picture: Retailers are contending with a disconnect on valuations, alongside inflation's impact on consumer spending, Mandarino says.

"[Retailers] are pressured from the pure economics of the transaction, and pressured from the demand side," he says.

By the numbers: S&P Global Market Intelligence clocked 64 bankruptcies in the consumer discretionary sector and 17 in consumer staples this year so far.

Overall there were 516 bankruptcies recorded through September, almost on par with the number of bankruptcies seen in 2020 in the same period.

The intrigue: "The number of retailers restructuring in bankruptcy, as a percentage of total bankruptcies for that year decreased, while the percentage of liquidations and asset sales has increased," according to BDO's bi-annual bankruptcy report.

Christmas Tree Shops, Shoe City (Esco) and Tuesday Morning went the liquidation route.

Meanwhile, Morphe parent Forma Brands sold to a collection of lenders, including Jefferies Finance, Cerberus Capital Management, FB Intermediate Holdings, and &vest in April.

David's Bridal got a court green light for a going concern sale to Cion Investment Corp.

Of note: A sale out of bankruptcy can be ripe pickings for a buyer, thanks to a provision that allows buyers to steer clear of the liabilities. "You can pick and choose as a buyer," Berliner says.

"That makes it a lot more desirable for some of these buyers to buy the assets of a retailer out of bankruptcy."

Bed Bath & Beyond liquidated its brick-and-mortar stores but sold the intellectual property of its eponymous brand name and digital assets to Overstock and BuyBuy Baby to Dream on Me.

What next: Mandarino says specialty retailers are particularly vulnerable, especially as you look at the recent crop that filed for bankruptcy this year.

The teen apparel sector may see some consolidation, he says, as well as home goods, such as bedding stores.

For those retailers "without a strong [e-commerce] presence, it's going to be super difficult," he adds.

This story has been corrected with Perry Mandarino's title as senior managing director and head of restructuring at B. Riley Securities.

2. The BFD: Debt comes knocking 

an illustration of a brown paper bag with a worried face printed on it

Separate from the entities it rates, Fitch compiles a watch list of companies in danger of default for both loans and bonds.

Its Top Market Concern Loans' and Top Market Concern Bonds' watchlists include department store chain Belk, automotive retailer Carvana, photo products retailer Shutterfly, pet retailer Petmate, crafts retailer Jo-Ann Stores, discount chain 99 Cents Only Stores, and home furnishings retailer At Home.

Also on those lists are restaurant supplier TriMark, frozen food maker Dessert Holdings, beauty companies Anastasia Beverly Hills and Rodan & Fields, and sewing machine maker SVP Worldwide.

Apparel maker Premier Brands, footwear maker Shoes For Crews, licensed apparel maker Mad Engine, and sports apparel maker Outerstuff are also listed. 

Rounding out those lists are food manufacturer Hearthside Food Solutions, restaurant chain Cooper's Hawk, and beer brewer City Brewing.

3. State of play: In danger of default 

Illustration of an overhead projector illuminating a square that says State of Play

We've compiled lists of distressed companies that we're keeping a close eye on, defined as CCC+ or Caa1 and below, which indicates a high level of default risk with a low margin of safety, from the top rating agencies. 

Of note: Fitch only had three companies on notice: Rite Aid, which just filed for bankruptcy, was given a D rating.

Fast-food chain franchisee GPS Hospitality was given a CCC+ rating.

Anagram, a balloon business that may be spun out of Party City's bankruptcy restructuring, per Bloomberg, was given an RD (for restricted default), meaning the company has defaulted on one or more of its financial commitments though it's still meeting financial obligations.

4. 👀 What to watch: A distressed retailers list

🏃🏻‍♀️ Situational awareness: WHP Global and Authentic Brands are reportedly circling Champion, CNBC reports, after the sportswear brand was put on the auction block by Hanesbrands amid activist pressure.

Programming note: Today we take a deep dive into the state of distressed retail. 

🍫 What we're eating: Kim grabbed some English toffee at her local Trader Joe's and it's been a match made in heaven ever since (her favorite is from New England).

✏️ Many thanks to newsletter editor Claire Rychlewski and copy editor Mickey Meece for today's edits.

🙏🏽 Thank you for reading Retail Deals. Catch you again tomorrow.

November 01, 2023

1 big thing: A short-lived holiday reprieve