A New ‘ Distress Cycle’ in Retail Seen Dawning
A Q&A with Hilco restructuring expert Richard Klein.
Where the COVID-19 pandemic flooded in and quickly swept away the vulnerable retailers — from J.C. Penney and J. Crew to Brooks Brothers and Neiman Marcus — the sector has been standing up better to the pressures in the economy today.
But a bout of inflation not seen in a generation, a big run-up in interest rates and continuing worries over recession are going to prove to be too much for some.
Already, David's Bridal succumbed to bankruptcy and, outside of fashion, Bed, Bath & Beyond is liquidating.
Retail is on edge and with good reason. To get a sense of what comes next, WWD spoke to Richard Klein, senior managing director of Hilco Corporate Finance, experts in restructuring. This conversation has been edited for length and clarity.
WWD: How busy are you going to be given the economy? Richard Klein:
We're in the early stages of a distress cycle where we'll see default rates tick up. But default rates are a funny thing because there's so much more debt out there today than ever before that you don't have to get to the level we've seen in other major downturns. There's so much more dead capital out there that even a 1 percent movement in default rates is going to keep people pretty busy.
WWD: Is there somewhere in the capital structure where companies are most vulnerable today? R.K.:
Capital structures are so much more complex than they were. Twenty years ago, it was rare to have a second lien. I've seen one-and-a-half lien debt, second lien, third lien debt. There's not much room for error in these capital structures these days.
WWD: You said we were at the beginning of the distress cycle. Does that mean more bankruptcies? R.K.:
I think so, yes. Either you have floating rate debt, debt which is going up, or you have fixed rate debt, mostly bonds. Hopefully you refinanced more than a year ago before interest rates started to tick up. If you didn't, capital's going to be more expensive.
WWD: Is there a profile of a company that’s feeling the most pressure now? R.K.:
Any company that's bumping up against covenants or availability on their liquidity line are companies that you're going to see have problems. What really is driving restructuring these days is maturity and/or liquidity needs.
WWD: So we have interest rates, inflation, worries about a recession and then, on top of that, we have a lot of companies with a lot of debt and a rapidly changing market. All of that leads to increased stress, more bankruptcies and restructuring. What happens when people get to you? R.K.:
You hope they come to you early enough that you've got time to help them implement operational changes or changes to their store footprint, be able to rationalize their footprint, get rid of underperforming locations so that the value proposition is there for them to restructure and survive.
WWD: It sounds simple, but a lot of retailers are optimistic. They’re builders, they’re growers. R.K.:
In my experience, whether it be a retailer or a restaurant chain, there's always a reason why that store is underperforming and it's going to turn around. Generally companies keep too many marginal stores when they should cut them. Because even if it's just breakeven, there's still a lot of capital being tied up in the form of inventory that could be deployed elsewhere.
WWD: Where is the value in retail companies today? R.K.:
You've got to look at the store footprint. You've got to look at the cash flows the business generates. That's certainly one of the reasons why so many liquidate, is because of the value of the inventory. But often one of the most overlooked pieces of value is the brand itself. We've seen brands get sold for much higher valuations than we would've expected.