In a year marked by economic turbulence, the retail industry is bracing itself for a storm as 11 major players face the daunting prospect of bankruptcy in 2023. From beloved craft store Joann to the familiar drugstore chain Rite Aid, these once-thriving businesses are now standing on shaky ground.
This revelation comes as a stark reminder of the fragility of the American economy. As we approach the final quarter of the year, consumers and investors alike are grappling with the implications of a potential retail reckoning.
The dire straits of these retailers have been attributed to a perfect storm of factors, including weakening consumer spending, soaring product, labor, and freight costs. Moody’s Investors Service, in a July report, predicted a surge in defaults within the retail and apparel sector, with default rates expected to rise from 6% to a staggering 8.6% over the next 12 months.
Adding to the economic uncertainty, S&P Global Ratings sounded the alarm on the possibility of a U.S. recession within the next year. While the risk may have slightly decreased since the start of the year, it remains a looming threat.
Elizabeth Han, a senior director at Fitch Ratings, emphasized the vulnerability of retail to economic fluctuations. She explained that discretionary spending, which constitutes a significant portion of retail revenue, tends to decrease during periods of economic uncertainty.
However, the challenges facing these retailers go beyond the broader economic landscape. Supply chain disruptions, inventory woes, and the specter of inflation are all casting long shadows over the industry. Fitch Ratings has observed a surge in distressed debt exchanges among retailers, exacerbated by high interest rates that have caught some businesses off guard.
One key indicator of the precarious situation facing these retailers is the FRISK score. This score, which measures the probability of bankruptcy within the next 12 months, paints a grim picture for many. Retailers like Joann, A.K.A. Brands, and Petco find themselves perched on the edge, with FRISK scores indicating a 10% to 50% chance of bankruptcy.
The common thread among these retailers is often their heavy debt burdens. David Silverman, senior director of Fitch Ratings’ U.S. retail team, highlighted how debt has been a determining factor in recent bankruptcies. He pointed to the strikingly similar stories of Abercrombie & Fitch and J. Crew, both mid-tier department store brands that faced financial turmoil. While one resorted to distressed debt exchanges and filed for bankruptcy early in the pandemic, the other managed to weather the storm due to a more prudent approach to debt management.
The situation is further complicated by the involvement of private equity firms. Many of the retailers at risk are currently owned or have had previous private equity ownership. Even sectors that appeared to thrive during the pandemic, such as home, pets, and crafting, are now feeling the strain. The initial boost these businesses experienced during lockdowns may have been temporary, masking underlying issues.
Joann, in particular, has experienced a rollercoaster ride since the pandemic hit in 2020. While the craft retailer initially benefited from a homebound consumer base, its fortunes have since waned. Sales plummeted by nearly 30% in Q2 2021 due to supply chain challenges and the fading effects of pandemic-related growth. The company has since been striving to cut costs, entering a $100 million facility to secure liquidity and undergoing significant corporate restructuring.
Similarly, Rite Aid, which saw a surge in demand for vaccines, COVID tests, and masks during the pandemic, now faces a different reality. The departure of its CEO in January and declining sales have raised concerns about its massive debt load.
The struggles of Big Lots and The Container Store underscore the challenges of adapting to changing consumer behaviors. Both have experienced double-digit sales declines and have resorted to cost-cutting measures.
Petco, despite benefiting from the pet adoption surge during the pandemic, is grappling with its high debt levels. The pressure to perform, coupled with an onerous capital structure, has left these retailers teetering on the brink.
As these retail giants grapple with their financial woes, the shadow of bankruptcy looms large. Their fates hang in the balance, and the economic implications of their potential downfall are far-reaching. The coming months will be crucial as these retailers fight to avoid becoming casualties of the economic storm that rages on.
