By Kashif, Investment Analyst at PrivCo, a private company financial intelligence platform
On an earnings call with investors in March, Urban Outfitters CEO Richard Hayne admitted something his fellow retail barons have known all along but have been reluctant to say: their businesses are really struggling, overcapacity is to blame, and it could get a lot worse.
“Our industry, not unlike the housing industry, saw too much square footage capacity added in the 90’s and early 2000’s. Thousands of new doors opened and rents soared; this created a bubble, and like housing, that bubble has now burst. We are seeing the results; doors shuttering and rents retreating.
This trend will continue for the foreseeable future and may even accelerate…”
Industry data supports Hayne’s claim that retail is in a downward spiral. Bank of America’s February 2017 report on credit & debit card spending showed that department store sales plummeted 15% y/y, a rate unseen since the last recession. And Credit Suisse predicted that the pace of store closures in 2017 will surpass anything in recent history, including the past two recessions.
Source: Credit Suisse
Importantly, Haynes emphasized that the U.S. has several times as much retail space per capita than Europe or Japan. Record low interest rates have allowed companies to take on cheap debt to expand beyond their means, and all that extra square footage requires more employees and inventory. And all that debt needs to eventually be repaid.
When demand slumps below expectations, excess inventory must be sold off with endless promotions. Discounts become the norm and impact revenues. Struggling companies end up closing stores and imposing layoffs with greater frequency in order to boost margins and productivity.
In the best case scenario, shareholders are temporarily appeased with the improved metrics of a seemingly more efficient retail operation. In the worst-case scenario, piled-up debt comes due as retail sales slump, sparking credit downgrades from ratings agencies in order to warn investors of an imminent default and/or eventual bankruptcy.
Moody’s list of distressed U.S. retailers is particularly telling: in 2017, the number of retailers on the list tripled compared to the 2008-09 recession. Many of these companies expanded their physical locations as consumers shifted to e-commerce or their demand fell off entirely.
While it’s easy to measure the impact of this trend on large, publicly traded retailers, it’s much tougher to get transparency on how privately-held retailers players are performing in this challenging landscape. Which retailers grew too fast and added excess capacity that may need to be shed as retail sales suffer? Which retailers are poised to weather the storm with more responsible and manageable growth?
We took a look through PrivCo’s private company database to examine some large privately-held companies on Moody’s list of distressed retailers in order to see what warning signs they shared in common, and if those patterns could foreshadow financial troubles at some other privately-held retailers we’ve been watching this year.
In our analysis, we first evaluated changes in store productivity (revenue / store) and net new stores added from 2013-15, moves that may have later contributed to a credit downgrade in 2016.