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No Trend in Retail Recovery

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Lisa M. Poulin 

Retail activity can indicate an approaching economic downturn as well as a recovery; and while the saying “retailers can lead us into a downturn, and lead us out of a downturn” may be true, we’re not yet seeing sustained improvement in the retail industry.

After a better than expected 2009 holiday shopping season, the dark, economic cloud seems to be lifting a little. It is evident from the improvement in capital markets that there is support for retailers, but the question remains: will the shoppers come?

Recovery indicators

Despite continued high unemployment and flat consumer spending, consumer confidence has risen in three of the last four months. In addition, perceptions about spending have shifted drastically in the last two years – from exuberant, conspicuous consumption to “shopping in our closets” and “necessities only” to today’s sentiment that discretionary purchases are fine, as long as the customer believes that they received the best value.

Retail, right now

Retailers have been cautious over the last year, aligning inventory levels with the current and fluctuating consumer demand, repositioning the brand to match the consumer’s new spending habits and capitalizing on e-commerce trends.  Essentially, a retailers’ success boils down to the quality of management’s decisions, the efficacy of their strategies and their ability to respond to changing consumer demand.

For example, the 2009 holiday season was successful for retailers, in part, due to increased discretionary spending. This was fortified, however, by retailers’ realistic inventory levels and reduced cost structures, which were aligned with new consumer demand and spending habits.

To make the transition between downturn and recovery, retailers are relying on a variety of strategies. One such strategy is inventory vigilance. Many retailers vastly reduced their inventory during the downturn. For these retailers, it is now a matter of balance to plan for modest sales while being flexible enough to meet increases in demand. Retailers are being extremely cautious and attentive to their inventory build. They are stocking items that have proven to sell and are keeping a close eye on fluctuating demand. Additionally, retailers have shifted their focus to try to limit inventory as much as possible so they are not left with product at the end of a season, even at the risk of losing sales. (Please see TMA Webinar Industry Update-Retail).

A recent example of this approach is Chadwicks of Boston, which walked the line between what is effective now and what will be scalable as demand increases. After consolidating its warehouses last year, Chadwicks maintained its warehouse capacity despite reducing inventory by 50 percent. This afforded Chadwicks the space flexibility needed to supplement warehouse capacity with an increase of labor costs, not real estate. (Please see TMA Webinar Industry Update-Retail).

Another strategy retailers can employ is brand repositioning. Luxury retailer Saks Fifth Avenue repositioned its brand recently, expanding it to reach a more price-conscientious consumer as it waits for its traditional customers to return. Seemingly Saks was successful in this endeavor, as its sales increased modestly at the end of the year after declining over 27 percent in the first quarter of 2009.

Most successful retailers also employ an e-commerce strategy. But cutting-edge retailers are using the Internet as more than an e-commerce store entrance. They are utilizing it as a marketing vehicle to reach and connect with existing and new customers. These retailers are capitalizing on emerging e-commerce opportunities on Facebook and Twitter as well as foursquare, which can be utilized to offer site-specific discounts or announce local events and promotions through geo-location technology.

In addition to the strategies above, many retailers are looking toward capital markets to assist them with their recovery. Now that the economy is beginning to shift, the capital markets have signaled an interest in supporting retailers. How retailers utilize new capital will determine their success, as it’s time to grow and show profits.

A look at capital markets

One recent, notable transaction was the April 2010 refinancing of Borders’ $90 million, five-year term loan and the restructuring of its $1.13 billion revolver with a July 2011 maturity date. Similarly, in May of 2010, Zale Corporation closed a deal with Golden Gate Capital for a $150 million loan and a restructuring of its revolver. In addition, The Bon-Ton Stores, Inc. increased its liquidity position in the fall of 2009 with a $75 million second lien credit facility as well. Liquidity and the time it affords will enable retail management teams to improve their core businesses in an increasingly dynamic and competitive market.

Retailers have also had success in capital markets with IPO’s for value-oriented merchants such as rue21 and Dollar General. These recent IPO’s will likely set a strong benchmark for the industry in the coming months. Additionally, private equity and strategic deals are being completed in the retail sector, including Walgreens’ acquisition of Duane Reade, Star Avenue Capital’s majority investment in J Brand and Golden Gate Capital’s acquisition of Eddie Bauer out of bankruptcy.

Changes in bankruptcy trends for retailers

In the retail industry, there appear to be two approaches to bankruptcy: avoid it at all costs or strategically go into a proceeding with the intention of closing or selling the operation. Realistic planning, particularly with respect to timing and establishing clear goals, is the best strategy to achieve a successful emergence rather than liquidation.

After numerous retail liquidations in the past few years, it is clear that the liquidators are very effective and that there is a price at which almost anything can be sold. Further, based on recent retail liquidations, to the extent that the lenders’ advances fall within the appraisals prepared by the liquidators for all assets, lenders will be protected. The markets have become very efficient and liquid, which is providing financing and enhanced liquidity outside of Chapter 11 proceedings.

However with increased leverage comes the possibility that should a retailer consider a bankruptcy, there may not be enough financing available to fund it. This results in a proclivity to liquidate or sell rather than reorganize the business.

Further compounding this complexity is the increased cash requirements for an emerging retailer, resulting from the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). Now, if retailers wish to emerge from Chapter 11 as a going-concern, they must have cash on hand to remit payment in-full for all payables relating to inventory delivered within the 20 days prior to filing, increased utility deposits, Ad Valorem Tax claims that have been elevated to a higher priority and increased priority limits for employee claims. Thus, the cash availability required to exit bankruptcy is quite high, especially given that these retailers are usually cash-strapped to begin with and also need the cash to fund their operational expenses. Also, with few or no unencumbered assets, securing additional liquidity to fund a filing can be difficult, if not impossible. Some retailers are finding the significant cash requirements of a Chapter 11 to be so high that they cannot afford to file for bankruptcy, and ultimately, they are liquidated.

Another new BAPCPA provision is the time to assume or reject leases, which cannot exceed 210 days. The result is that the length of time that a retailer can remain in the Chapter 11 process essentially is limited to 210 days. Bankruptcy judges do not have the discretion to grant an extension to the assumption or rejection; only the landlords can agree to the extension, which can be problematic when there are numerous landlords in a case. As such, retailers and lenders must make all the critical decisions in the case within the 210-day time frame or risk the loss of a lease through a liquidation sale.

The reduced time frame for a Chapter 11 case limits the operational improvements that can be incorporated into the business plan strategy as well. It is no longer realistic to use the bankruptcy process to conduct a repositioning of a business, make material changes, experiment with different store formats or introduce new products. Pre-BAPCPA, retailers tested the impact of new strategies on their performance during the holiday season, evaluating and adjusting the business plan based on consumer spending. Without the capability to experiment with different strategies, business plans are dependent on speculative changes, and liquidation is then perceived as less risky, with more predictable recoveries.

Therefore, under the new BAPCPA rules, the bankruptcy process for a retailer is usually a transactional process, such as an asset sale, store-closing process or a combination of the two – and whatever the purpose, it needs to be completed quickly or liquidation may be inevitable. All of this contributes to making a Chapter 11 filing an unattractive strategy for retailers; therefore there should be fewer retail filings in the near-term.

Conclusion

The last two years have seen nearly a 180-degree change in consumer behavior; shoppers are still wary but more optimistic about the economy, despite the high unemployment rate.

Most retailers view 2010 as a transition year. Most likely, it will establish the baseline for financial projections for the next several years. With their options increased by capital markets but limited by the bankruptcy process, the sustainability of retailers will be measured by the ability of management to deftly respond to the changes in the economy and astutely predict consumer reaction, adjusting operations accordingly. The retail industry’s recovery will be neither fast nor easy, and agility may be the determining factor for survival.