Junk-Bond Traders See Black Friday Flop

For lenders to the most debt-laden retailers, the holiday shopping season is already turning out to be a bust.

Bonds of junk-rated merchants are handing investors the biggest monthly losses in more than four years, pushing borrowing costs for the companies to the highest since 2012, according to Bank of America Merrill Lynch index data. Men’s Wearhouse Inc. debt has lost 23 percent during the month. Bonds of preppy clothier J. Crew Group Inc., are trading at a little more than a third of their face value, and prices on children’s retailer Gymboree Corp. have fallen even lower.

“The holiday season is not going to save anybody,” said David Tawil, president of distressed hedge fund Maglan Capital LP.

A warm U.S. autumn has left merchants with inventory piling up on their shelves and slowing mall traffic. That’s exacerbating pressures they already faced from online retailers. Shoppers have increasingly shifted purchases toward services and experiences, and to big-ticket items like autos and home-improvement projects. 

With department stores like Macy’s Inc. and Nordstrom Inc. cutting their annual profit forecasts, concerns are growing that the industry is headed for another shakeout that pushed the likes of RadioShack Corp. and surfwear chain Quiksilver Inc. into bankruptcy protection this year.

J. Crew bonds have been among the hardest hit, losing almost half their value in the past three months. The company is owned by TPG Capital Management LP and Leonard Green & Partners LP.

‘Very Weary’

“We are very weary of what we are seeing in retailers,” said John McClain, a money manager at Diamond Hill Capital Management Inc. in Columbus, Ohio, which oversees $16 billion. The fund, which invests in apparel makers including VF Corp., owner of Lee jeans, is staying away from the sector, he added. “Many of them have a lot of debt, are performing poorly and as a result they are getting taken out to the shed.”

The trend has forced at least seven retailers into bankruptcy in the last 12 months. RadioShack, American Apparel Inc. and Quiksilver all filed for Chapter 11 protection after their revenue tanked and cash dried up. These conditions may not change fast enough to help some deeply troubled merchants.

One distinct characteristic of retail bankruptcies is more than half end up in liquidation, compared with less than 5 percent in other industries, according to a research report by AlixPartners LLP, a restructuring advisory firm that tracked U.S. bankruptcy cases for the 10-year period from 2005.

Some market participants see hope for these and other retailers because the companies are more desirable.

Dining, Vacations

“In the last wave, it was a lot of straight liquidations, because people just couldn’t see the value,” said Derek Pitts, who specializes in financial restructurings at Houlihan Lokey. “The next wave is more higher-quality businesses, higher-quality credits, where the question is still open as to whether they have a reason to live or not.”

The fact remains that U.S. consumers aren’t spending the way they used to. And that spells trouble for a long list of struggling merchants. Instead of picking up another sweater, shoppers these days are more likely to dine out or put money toward a vacation. When they do buy, many shoppers are turning to small businesses that may have more unique offerings. Plus, they’re saving more.

This reality is reflected in the debt markets. Speculative-grade bonds sold by retailers are eking out a 0.5 percent return in 2015, giving investors the slimmest gains in seven years. The debt has lost 2.7 percent in November. Before this year, junk-rated retail bonds had provided investors annual average gains of more than 17 percent as the companies took on more and more debt. Outstanding obligations in a Bank of America Merrill Lynch index of U.S. junk-rated retail bonds more than doubled to $42.5 billion since 2008.

Teen Apparel

One of the key issues is that mall-based children-and-teen apparel stores such as Gymboree and Aeropostale Inc. operate in a competitive segment where traffic continues to decline. Their businesses have also suffered as competitors like J.C. Penney Co. and Kohl’s Corp. improved their children’s clothing departments.

Margot Fooshee, a spokeswoman for J. Crew, Luke Barrett, a spokesman at TPG, and representatives for Aeropostale declined to comment. Representatives for Leonard Green, Men’s Wearhouse and Gymboree didn’t respond to messages seeking comment.

“I expect that we are going to see more future bankruptcies in the sector," said Steven Ruggiero, a retail analyst at RW Pressprich & Co. "Many retailers are entering this holiday season with excess inventories, and I expect that it will be a promotional environment, which will pressure margins."

To be sure, J.C. Penney’s turnaround is taking hold as Chief Executive Officer Marvin Ellison, former Home Depot Inc. executive, tries to rebuild the century-old retailer that was on the brink of collapse after a failed reinvention. Penney’s 8.125 percent unsecured bonds maturing 2019 have returned 14 percent including interest this year, trading Thursday at 95.25 cents on the dollar.

While the rest of the retail industry waits to see what the rush of holiday shoppers brings, analysts and investors remain skeptical that a turnaround will occur anytime soon.

“We are going into the holiday seasons with multiple headwinds coming from macro conditions, industry issues and company-specific problems,” said Maglan’s Tawil. “The bottom line is: The weather outside is very hot, the disposable income is not.”

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