Monday, 20 August 2018

Troubled US retail space spells pain for bondholders

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Investors are shunning the bonds of US retailers, even though much of the paper from the troubled sector is available at bargain-basement prices.

Dismal results - and even worse trend-lines - have convinced much of the buyside that the days are numbered for US retail, which has been undone by online shopping and focused value-buying by consumers that has eaten into margins.

Retailers have delivered the worst returns so far this year, at negative 1.684%, of any sector in the US high-yield space, according to Bank of America Merrill Lynch data.

And many in the market expect a wave of defaults and restructurings ahead, which means even opportunistic investors want nothing to do with the debt.

“It’s hard to be a buyer of distressed retailer debt right now,” Duncan Vise, an analyst at Invesco, told IFR.

Yet some say the worsening sentiment has come as a surprise, noting that the industry’s headwinds have been in place for some time - and that the sector did well until recently.

Indeed, junk-rated retail returned an impressive 12% in 2016, according to BAML data.

But hopes for a business turnaround finally appear to be fading, replaced by the reality that there are limits to how long the market can ignore the obvious.

S&P said there could be at least as many defaults this year as the six seen in retail in 2016, while Fitch said the sector will play an increased role in the loan default rate this year.

“Some people had been hoping for better results prior to the holidays,” one retail credit analyst said.

“The macro picture was better, inventories were in better check, the weather wasn’t bad and there were more shopping days before the holidays. But none of that appeared to matter.”



Even some of the most long-lasting names in US retail - from everyman chain Sears to luxury store Neiman Marcus - are in danger of falling by the wayside.

Sears warned this week that it might not survive. Media reports say Payless ShoeSource is preparing to file for bankruptcy soon.

And Neiman Marcus is considering an outright sale of the company, a move that would be extremely difficult to pull off unless bond or equity holders take steep haircuts. nL2N1GT15X

Analysts say the ability to refinance debt will be crucial to surviving the downturn, especially for those companies that have not got to grips with their balance sheets.

According to S&P, for example, Sears and J Crew have only US$625m and US$500m in debt, respectively, but have less than adequate liquidity to repay it. nL2N1GE1G6

And bondholders are meanwhile feeling the pinch.

Children’s clothing store Gymboree’s 9.125% 2018 bonds are the biggest loser in US high yield this year, according to JP Morgan, and are currently trading at 9.5 cents on the dollar, Trace data shows.

The company, acquired by buyout firm Bain for US$1.8bn in 2010, said that it did not have enough cash to meet US$871.9m of liabilities due in the next year and has hired advisers to help in talks with lenders and bondholders to restructure or refinance its debt.

“With retail, we think it is a secular decline,” said George Schultze, CEO of hedge fund Schultze Asset Management.

Wells Fargo analysts said retailers must act swiftly to adapt to changing consumer demand by aggressively closing stores and adjusting to lower-margin structures.

“Many highly levered retailers face daunting prospects for improving their balance sheets that were put in place in better times,” they wrote in a note.



Some companies such as J Crew are transferring material assets that included trademarks into unrestricted subsidiaries, further dimming the prospects of a full recovery for holders of distressed retail bonds.

This move to shift intellectual property away from creditors has particularly alarmed bondholders.

“It’s a real problem for our markets,” said the retail analyst.

“If you rip out the intellectual property - the core of the value - the business basically becomes a distributor for other people’s products,” he said.

“That’s a completely different business model.”

Those companies that own real estate may have more to recover in terms of assets, but even in those circumstances, some buyside accounts are working big valuation haircuts into their investment decisions.

But some say that, despite the upheavals, the retail sector still offers some hope.

“People believe that malls won’t exist and there will be no need for a physical store,” Henry Peabody, a portfolio manager at Eaton Vance Investment Managers, told IFR.

“When sentiment changes that much, it creates opportunities,” he told IFR.

“The problem is we’re at the very early stages of this. So it means you have to pick your spots.”


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