Risky Debt Is Moving to Retail and Health CareBy
Higher rates, new policies will spur restructurings in 2017
Investors are broadening their outlook on risky debt trading
Good news for investors: distress is spreading.
The combination of rising rates and a new political regime in the U.S. will bring about an uptick in corporate restructurings outside the energy space, creating new opportunities for investors in the riskiest parts of the debt market.
That’s one of the conclusions from interviews with bond traders, bankruptcy lawyers, financial advisers and fixed-income analysts about the outlook for 2017. Investment options will become more diversified as the primarily energy-driven distressed market of recent years will broaden out, according to Tim Coleman, head of restructuring at PJT Partners Inc. Sectors to watch could include utilities, health-care providers and more companies in the struggling brick-and-mortar retail sector.
“We’re going to see more ordinary restructurings instead of just a lot of commodity-driven activity,” said Coleman, who has worked on major corporate restructurings including Ford Motor Co. and Delta Airlines Inc. “That’s probably better for the distressed space.”
The dynamic is straightforward: poorly performing companies in struggling or changing industries will have a hard time repaying their debt as borrowing costs rise amid expectations for higher inflation under President Donald Trump. S&P Global Ratings expects to see more downgrades than upgrades in 2017.
Restructurings will happen in certain pockets of pain where the broader economic trends exacerbate existing problems and “weed out very quickly those companies that have borrowed too much,” according to Mike Barnes, co-chief investment officer at Tricadia Capital Management, which oversees $2.8 billion.
Here’s a look at where experts say those pockets of activity will be.
What’s going on: Brick-and-mortar retailers are struggling to attract shoppers to their stores as online competitors such as Amazon lure away consumers with free shipping and the convenience of purchasing from their sofas. Macy’s Inc., the largest department-store company in the U.S., slashed 6,200 jobs and said it will close 100 stores in an effort to slim down. Sears Holdings Corp. also announced plans to shutter 150 stores. The troubles will only exacerbate the problems of debt-laden companies like Gymboree Corp. and Claire’s Stores Inc.
Where will it happen: One of the most pressing parts of the sector facing immediate turmoil is teen-fashion retailers, according to Jim Mesterharm, head of North American turnaround and restructuring at AlixPartners.
“You certainly have issues in teen fashion that are always going to be there, where styles change and sectors get overpopulated and there has to be a shakeout,’’ said Mesterharm, who has served as chief restructuring officer at multiple companies including Eastman Kodak Co.
When will it happen: The market can expect to see a flood of retail restructurings early in the year, said bankruptcy lawyer Ed Weisfelner, a partner at law firm Brown Rudnick who’s been in the field for more than 30 years and worked on high-profile cases that include representing Icahn Partners in the Trump Taj Mahal bankruptcy.
“The first quarter is usually big for retail filers who didn’t make enough during Christmas,’’ he said. “Some of them already hit, like Sports Authority and American Apparel, but my guess is there’ll be a lot more smaller and medium-sized ones.”
Names to watch: J. Crew Group Inc., Claire’s, Sears Holdings Corp., Nine West Holdings Inc. and Gymboree. Representatives for J. Crew and Nine West declined to comment, while spokesmen for the other retailers didn’t respond to messages.
What’s going on: The stocks and bonds of health-care companies plunged following the U.S. election in November amid expectations that Republicans would use their majority in Congress to significantly change President Barack Obama’s health-care overhaul from 2010.
Where will it happen: Some areas that could experience the most turmoil include hospitals and pharmaceutical companies, according to Bill Raine, a portfolio manager at Contrarian Capital Management, which oversees $3.9 billion. The firm’s flagship fund was up nearly 25 percent for 2016 as of mid-December.
When will it happen: “There are definitely going to be winners and losers out of whatever replacement we see for Obamacare,” Raine said. “Right now we have very little in health care, but we think that over the next couple years there’s probably going to be quite a lot to do.’’
Names to watch: Concordia International Corp., Community Health Systems Inc. and Valeant Pharmaceuticals International Inc. Representatives for the companies didn’t respond to requests for comment.
What’s going on: “We’re starting to see more in utilities, and those restructurings tend to be big and messy,’’ said AlixPartners’s Mesterharm.
Where and when will it happen: “As things shake out regarding issues with fossil-fuel consumption and regulation around coal and thermal power plants, we’ll see challenges between the regulated and deregulated sides,’’ Mesterharm said.
Names to watch: FirstEnergy Corp., Homer City Generation and TerraForm Power Inc. FirstEnergy said it’s exploring alternatives for its competitive generation business. A Homer City spokesman declined to comment and TerraForm’s representative didn’t respond to a message.
What’s going on: A diversification of opportunities doesn’t mean investing in the distressed commodity space is over. Higher oil prices could be a bright spot for traders who want to take risks on energy names, according to Tricadia’s Barnes.
“There’s now a better clarity and greater expectation of recovery values in oil distressed sectors,” Barnes said. “Suddenly, where we were passing before in a lot of oil and gas credit opportunities in the distressed set, recently we’ve seen more interesting opportunities.”
Where and when will it happen: “With a quarter of the weakest links right now in the U.S. oil and gas and metals, mining and steel, you’ll continue to see commodities-related companies in the near-term drive the default rate in the U.S.,’’ said Diane Vazza, head of global fixed income at S&P Global Ratings.