Photographer: Marlene Awaad/Bloomberg

Why J. Crew Is Unraveling

  • The holiday shopping seasons isn't going to offer a boost
  • Drexler has a back-to-basics comeback plan in the works

In the 21 months since speculation swirled that J. Crew Group Inc. was thinking about going public, not much has gone right.

Sales have slumped, a comeback plan hasn’t taken off and now comes a ho-hum Christmas shopping season that analysts say is unlikely to give the once high-flying clothing retailer a boost. Investors are growing increasingly concerned. Prices on J. Crew’s benchmark bonds have sunk to about 25 cents on the dollar, a level that indicates holders are bracing for a debt restructuring.

“Their fashion isn’t particularly special right now, they still have some quality issues, and people aren’t buying apparel, and the weather’s not cooperating,” said Liz Dunn, chief executive officer of the consulting firm Talmage Advisors. “I don’t think there are many apparel players that are going to stand out this holiday season -- and J. Crew certainly isn’t one of them.”

Early last year, still in the glow of First Lady Michelle Obama and her daughters wearing the brand at the 2013 inauguration, J. Crew was interviewing banks as it considered an initial public offering, according to people familiar with the matter. Now its bonds are the worst-performing retail debt in the U.S., having lost 49 percent just since August. Other merchants are suffering, and chains including Macy’s Inc. have slashed profit forecasts. But J. Crew is feeling the squeeze more than most, weighed down by $2.1 billion in debt and same-store sales that have slipped for five out of the last six quarters.

Back-to-Basics Plan

What happened? Simple, as CEO Mickey Drexler said on a conference call in June: “We just made mistakes.” And how to turn it around? That’s not so easy.

The company has had to offer deep discounts to make room for the new products that are part of its back-to-cool-preppy-basics comeback effort, and now competitors with excess items are forcing it to keep reducing prices, said Hale Holden, an analyst at Barclays Capital. “The big issue is the inventory. Not only do you have to have stuff in the stores that folks want to buy, but you have to price competitively -- if the store across the street is discounting, you have to mark down as well.”

And discounts are in, because it’s a tough time for all apparel retailers, with too many Americans preferring to spend disposable income on big-ticket items like cars or at beauty salons or restaurants rather than shelling out for jackets and jeans. Mall traffic has been sluggish, the weather unseasonably warm. Gap Inc. and Nordstrom Inc. are among those that have cut fourth-quarter outlooks.

‘Fashion Miss’

Drexler has a lot riding on getting things right again. The former Gap CEO took J. Crew private in 2011 with equity firms TPG Capital and Leonard Green & Partners LP, and they need an exit strategy. J. Crew and the firms declined to comment.

The $11 million investment Drexler made in the company when he became CEO in 2003 grew to a more than $300 million stake after it went private. But soon, J. Crew started to flag. While the 89 Madewell-brand stores are doing well, Drexler acknowledged earlier this year that the flagship brand had gotten away from its classic roots, and that quality was wanting in some items while fits were wrong in others. Younger shoppers decamped for less expensive stores like Hennes & Mauritz AB and Inditex’s Zara, and loyal customers were alienated by the switch from blazers and pencil skirts.

“They had a bit of a fashion miss, which was their own doing. They’ve also been hit by weak retail traffic overall,” said Carla Casella, an analyst at JPMorgan Chase & Co. “The consumer is less loyal today -- they’ve got their shopping cart in their hand all the time and can cross shop more easily than in the past.”

Free Publicity

Drexler has hustled to turn things around. He named Somsack Sikhounmuong, who had been Madewell’s head of design, to lead women’s design at the flagship brand in June and cut 175 jobs, mostly at corporate headquarters. The company started a new factory-outlet line of shops called Mercantile, putting them in mainstream shopping centers. It’s also continued its international expansion. J. Crew has more than 280 stores in the U.S., 18 in Canada, four in the U.K, two in Hong Kong and one that opened in Paris in March.

It scored free publicity in a collaboration with Jimmy Fallon, who introduced his invention, a $48 iPhone case designed to look like a pocket square, earlier this month during his gig as “The Tonight Show” host. His Pocket Dial is on sale at J. Crew as a stocking-stuffer special, with proceeds from the collaboration to go to charity.

The company reports third-quarter earnings next week. In the second quarter, which ended Aug. 1, revenue fell 5 percent -- and at the J. Crew brand alone it was down 10 percent. Sales online and at J. Crew stores open at least a year declined 13 percent.

At least one restructuring advisory firm has contacted J. Crew’s owners offering its services, according to a person with knowledge of the matter. The long timeline before the bonds mature helps reduce the risk the company will have to refinance at an unfavorable rate, said Michael Zuccaro, assistant vice president and analyst at Moody’s. “While performance is really weak now, there’s no real need to go to the market.”

J. Crew’s $500 million 7.75 percent senior unsecured bonds maturing May 2019 last traded at 25.5 cents on the dollar on Nov. 24, losing 60 percent in value this year, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The securities, which were issued in October 2013 at par, were trading above 90 cents on the dollar as recently as April. The precipitous fall marks J. Crew’s bonds as the worst-performing retail debt in the U.S. That’s in comparison to a 3.3 percent gain in high-yield bonds in the sector, according to Bank of America Merrill Lynch data.

Moody’s revised its credit ratings outlook for J. Crew in September to negative from stable. “If this performance does not begin to improve, we start to worry that its capital structure will become increasingly unsustainable,” Zuccaro said. “It has a track record of being able to correct fashion issues -- but this environment is more challenging than what they’ve seen in the past.”

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