(Bloomberg)—Visitors to the newly redeveloped Kings Plaza shopping mall in Brooklyn later this year will encounter new, multilevel Primark and Zara stores. Names not on the directory? Debt-laden older brands such as J. Crew, Rue21 and True Religion.
“Euro fast fashion,” featuring trendy clothing that can move from catwalks to stores in mere weeks, has taken the U.S. by storm, and distressed specialty apparel retailers are among the biggest casualties. Their business models and balance sheets are in tatters, especially at smaller and slower chains that jacked up debt during leveraged buyouts.
Besides fast fashion, traditional chains are being hurt by the quickening shift to online shopping as competitors led by Amazon.com Inc., No. 1 in the Internet Retailer 2016 Top 500 Guide, lure away consumers with free shipping and the convenience of buying from their sofas.
“Today’s customers think differently,” says S&P Global Ratings analyst Helena Song. “It’s so easy to lose your customers, and they never look back.”
The shift in consumer habits has left plenty of apparel retailers short on cash just when they need it to buy updated systems and keep their shelves constantly refreshed to keep pace with their newer, nimbler rivals. The result has been the biggest spate of restructurings and bankruptcies since the Great Recession. There are more on the way.
“Companies that have the highest leverage are going to be the least able to address those challenges and invest the capital necessary to explore different strategies and evolve the business models,” says Chris Grubb, a managing director in Greenhill & Co.’s restructuring group who focuses on struggling retailers. “There will continue to be a slew of these smaller filings.”
Moody’s Investors Service lists 18 retail and apparel names as “very high credit risk.” That’s “the highest number I can remember since certainly the recession, and I don’t recall us getting to that level even then,” said Moody’s analyst Charles O’Shea.
Younger shoppers have gravitated to fast fashion brands not only because they’re more affordable but also because they’re able to quickly capture the latest looks and make them available in a fraction of the time traditional merchants need. Cheaper prices also mean customers of these brands, sometimes referred to as disposable fashion, have come to expect an ever-changing assortment.
The competition exacerbates the crunch at companies like J. Crew Group Inc. (No. 49 in the Top 500) as they scrounge for cash to respond. The most immediate risk is for chains that are smaller, highly levered, and often private equity-owned, Greenhill’s Grubb said. J. Crew, Claire’s Stores Inc. (No. 455), Gymboree Corp. (No. 365), Rue21 Inc. (No. 453) and True Religion Apparel Inc., No. 705 in the Internet Retailer 2016 Top 1000, the five most troubled companies on S&P’s list of retailers on negative outlook, all fit that profile with credit ratings deep in junk territory.
Some have sought breaks from creditors such as debt swaps and extended loans or hired financial and legal advisers for restructurings.
J. Crew, backed by private-equity sponsors TPG Capital and Leonard Green & Partners LP after a 2011 buyout, added two directors with restructuring expertise to the board this month as the value of its $1.5 billion term loan was sinking toward 55 cents on the dollar. High leverage is also squeezing chains less affected by fast fashion. Claire’s, bought by Apollo Global Management LLC in 2007, has repeatedly squared off with creditors over new terms, and Gymboree, laboring under debt from its Bain Capital buyout in 2010, has said it’s looking into refinancing or repurchasing senior notes.
Representatives for True Religion and Rue21 declined to comment, while representatives for J. Crew, Gymboree and Claire’s didn’t respond to requests for comment.
Fast fashion is an expensive proposition for traditional specialty merchants, who are often lagging behind on replacing stale inventory or are sacrificing merchandise quality, S&P’s analysts said.
“A lot of them are hamstrung by their supply chains,” S&P’s Robert Schultz says. “Even high-end brands are going into fast fashion.”
Less-indebted apparel names, while still facing the same secular pressures, are better equipped to adapt. American Eagle Outfitters Inc. (No. 63), for example, managed to keep 2016 revenue growing through Oct. 29. The teen fashion merchandiser has virtually no debt, with just $8 million drawn on a $400 million revolver.
Specialty apparel shouldn’t expect a break anytime soon. Holiday retail sales increased 4% in 2016 to $658 billion, according to the National Retail Federation, with nonstore sales growing faster than forecast at 12.6%. Department stores are struggling to face the changing industry too, with Sears Holdings Corp. (No. 14), Bon-Ton Stores Inc. (No. 169) and Neiman Marcus Group (No. 36) all on the S&P list of highest-risk companies with negative outlooks. Many of the chains are closing stores to cope with sluggish mall traffic, with Sears planning to shutter another 150 locations. A representative for Sears declined to comment; the other two chains didn’t respond to requests for comment.
Malls may also come under pressure as closing retailers leave them with empty storefronts and broken leases. More than 10 percent of U.S. retail space, or nearly 1 billion square feet, may need to be closed, converted to other uses or renegotiated for lower rent in coming years, according to data provided to Bloomberg by CoStar Group.
Trade policy reform under President Donald Trump’s new administration could cause further pain by making it more expensive to import apparel, Bloomberg Intelligence analyst Poonam Goyal wrote in a report this week. More than 90% of apparel purchased in the U.S. is produced abroad, and additional import costs could hurt retailers’ margins, according to the report.
The larger companies may be able to survive longer, as their size and balance sheets afford them more flexibility, but they’ll have to face the changing times, too, says Greenhill’s Grubb.
“It’s not just a balance sheet issue, it’s an operational issue and a fundamental business model issue for a lot of these companies,” he says.
A telling sign: The shining, new Primark store in Kings Plaza is replacing a Sears.Favorite