By Martinne Geller - Analysis
NEW YORK (Reuters) - Dozens of U.S. retailers are being closely watched by bankruptcy and restructuring professionals as the crucial holiday sales season approaches.
Those at greatest risk are chains selling goods and services considered nonessential, or ones that are loaded with debt, say analysts and investors who follow distressed companies.
That’s because with the biggest U.S. financial crisis since the Great Depression now slamming credit markets, holiday shopping could be its weakest in years as consumers continue to struggle with higher food and energy costs and job losses.
One closely watched chain is Circuit City Stores Inc (CC.N), which reported a wider quarterly loss on Monday and withdrew its financial outlook. The consumer electronics retailer said it was reviewing ways to attract consumers during the holidays after more than a year of sales declines.
Before the report, Deutsche Bank’s Mike Baker said in a note to clients that if Circuit City does not have a strong holiday season it “significantly increases bankruptcy risk.”
Citing its $1.3 billion credit facility, spokesman Bill Cimino said Circuit City believes it has adequate liquidity to support its business through a multi-quarter turnaround, given the support of its vendors.
“We’ve undertaken a series of actions today to help accelerate our turnaround and the goal of that is to maintain and increase equity value within the company and drive shareholder value,” Cimino said.
On Monday, Circuit City said it could close stores as part of a turnaround plan and that it would suspend store openings during fiscal year 2010.
Other retailers that need to bring in a successful holiday sales season include Eddie Bauer Holdings Inc EBHI.O, Claire’s Stores Inc, Guitar Center, Loehmann’s and Oriental Trading Co, and fast food chains Krispy Kreme Doughnuts Inc KKD.N and El Pollo Loco Holdings. They all have a “B-” or lower credit rating by Standard & Poor‘s, or are on review for possible downgrade or they have a negative outlook.
“These are clearly in, and have been in, our portfolio of weakest links,” Diane Vazza, head of S&P’s global fixed income research unit, told the Reuters Restructuring Summit last week. “You can think of them as potential defaulters.”
Officials at most of those chains declined to comment or did not return calls.
El Pollo Loco Chief Financial Officer Joseph Stein said the chicken chain’s finances had been boosted last year by a $45 million cash infusion from private equity firm Freeman Spogli.
“We are probably in better shape than a lot of other companies out there because we have that additional liquidity,” Stein told Reuters. “The whole restaurant industry is at risk because of decreased consumer spending, so any highly leveraged companies ... are at higher risk.”
U.S. consumers, who account for more than 60 percent of the U.S. gross domestic product (GDP), are confronting the collapse of the housing market, financial market volatility, and tighter credit. Forced to focus on essentials, they have reined in spending on discretionary goods and services like dining out and luxury items such as jewelry.
This has put a lot of pressure on a number of retail chains, including Linens ‘n Things, cookie company Mrs. Fields Famous Brands, Steve & Barry’s and Goody’s clothing stores, and department store chains Boscov’s and Mervyn‘s, all of which filed for bankruptcy protection this year.
S&P’s Vazza said an “avalanche” of U.S. high-yield bond defaults may hit in 2009, partly fueled by years of easy loans and a wave of buyouts by private equity firms that typically put up only a little cash and leveraged the rest with debt.
About 70 percent of defaults in 2008 came from companies that had private equity investment at some point, she said.
Private equity firms such as those that bought Michaels Stores for more than $6 billion or Claire’s Stores for $3.1 billion were often attracted to retailers’ strong cash flows, which they used to pay down debt tied to the deals.
But over the past year, sales have slowed and many debt-ridden chains are finding it hard to pay store rents and high interest payments, said Brian Cooper of GB Merchant Partners, a private equity affiliate of liquidator Gordon Brothers.
In many cases the deal values of the leveraged buyout boom were overpriced, he said. As retailer sales and stock prices have declined, some are now in situations similar to homeowners who are paying mortgages that exceed the value of their homes.
“It requires a lot of capital to cover these fixed costs,” Cooper said. “I don’t think the banks really took into consideration what would happen if all of a sudden it was a rainy day.”
Last week Moody’s Investors Service confirmed its long-term rating on Claire‘s, including its probability of default rating, at “Caa1” due to a “higher-than-average probability of default over the near-to-medium term, given what we view as an over-leveraged and unsustainable capital structure.”
Still, heavy debt is not the only problem.
“A retailer’s success is not just limited to the balance sheet,” said William Susman, president of investment bank Financo Inc. “They really need to have customer relevance and merchandise relevance.”
Neither chain returned a call for comment.
Nina Kampler, an executive vice president in retail liquidator Hilco’s real estate division, says many more retailers are facing serious difficulties.
Those at risk include “everything but the discounters,” which may be able “to assume some of these more distressed, troubled retailers,” she said.
Some of the most troubled retailers have been jewelers, since their goods are easily given up in tough times. Demand has been so tight that Buxbaum Group last week said it was launching a new liquidation venture just for jewelry stores.
Buxbaum cited a forecast from credit information provider Jewelers Board of Trade that 20 percent or more of independent jewelry stores may go out of business in five years.
Additional reporting by Sarah Coffey, Aarthi Sivaraman, Dena Aubin, Walden Siew and Karen Jacobs