These 6 Retail Companies Are Toast (Get Out Now)

Teeny-bopper fashion retailer Aeropostale made headlines last week when it filed for Chapter 11 bankruptcy, had its stock delisted from the NYSE, and announced a plan to close 154 out of 800 stores – all after a disastrous $136.9 million net loss in 2015.

This morning, Gap Stores reported lousy sales and plans to close stores to deal with what it called a “tepid macro environment for apparel retail” while admitting that changes it made to its product designs and selections have been slow to catch on.  Gap stock plunged 10% after the announcement.

And last month, Sears’ slow-motion death march continued with an announcement that the company is closing 70 more Sears and K-Mart stores.

The retail industry is in crisis.  Buffeted by structural changes such as the explosion of ecommerce, weak consumers and an increasingly selective consumer base, there’s been an epidemic of mall-based retailer bankruptcies lately (Sports Authority, RadioShack, Aeropostale, American Apparel, Pacific Sunwear…) and it’s only going to get worse. Thanks to heavy borrowings by their private equity owners (in some cases to pay dividends to reduce or eliminate their investments in these companies), most mall-based retailers that were taken private are likely to default on their bonds when they reach their maturity dates over the next couple of years…

When that happens, these six companies will be the first to go.

And you’ll be able to make a sizeable profit – if you do this.

The Slow Bleed In The Retail Industry Is About to Turn Fatal

The corporate credit cycle is at least two years from bottoming. Unlike previous default cycles, which occurred in a normal interest rate environment, this default cycle is delayed by low interest rates that let borrowers (particularly those owned by private equity firms that have a huge incentive to delay default as long as possible to prolong their management fees) delay restructurings and bankruptcies longer than in earlier cycles. The fact that so many energy companies filed for bankruptcy so quickly shows the severity of the energy price collapse, but other industries like retail are bleeding more slowly.

However, that trickle is now becoming a steady stream.

A Bankruptcy Timeline

  • February 2015: Cache Inc., women’s dress retailer, files Chapter 11.
  • February 2015: RadioShack files Chapter 11.
  • April 2015: Frederick’s of Hollywood files Chapter 11.
  • June 2015: Anna’s Linens files Chapter 11.
  • September 2015: Quiksilver, surfwear retailer, files Chapter 11. In January 2016, the company emerges from bankruptcy; it is now controlled by private equity firm Oaktree Capital.
  • October 2015: American Apparel files Chapter 11, after years of losses.
  • January 2016: Wet Seal, teen fashion retailer, files chapter 11.
  • February 2016: Hancock Fabrics files Chapter 11 for the second time, closing 70 of its stores and liquidating inventory at the other 185.
  • March 2016: Sports Authority files Chapter 11, saying it would close 140 of its 450 stores.
  • April 2016: Pacific Sunwear of California files Chapter 11.
  • April 2016: Vestis Retail Group, the operator of sporting goods retailers Eastern Mountain Sports, Bob’s Stores, and Sport Chalet files Chapter 11, closing all 56 stores.
  • May 2016: Aeropostale files Chapter 11.

The retail industry is experiencing a slow death spiral with mall-based retailers melting away before our eyes like the Wicked Witch of the West. The following companies’ bonds are trading at distressed levels and are waiting for their maturity dates over the next several years to default:

  • J. Crew
  • Rue 21
  • Claire’s Stores
  • Gymboree
  • Nine West Holdings
  • Men’s Wearhouse

Unless their private equity sponsors step up and repurchase their bonds, these companies are toast. With the exception of Gymboree, which just tendered for $40 million of bonds at 52% of par (which included a large tender premium), none of these sponsors have stepped up to do so, suggesting they lost confidence in the businesses and are just milking them for fees. (I’ve discussed the opportunistic behavior of the private equity market here.)

The fate of the retail industry is closely tied to the junk bond market.  And just as investors jumping back into equities to chase the recent rally are likely to get burned, those investing billions of dollars in the junk bond market are also tempting fate. There is $1.2 trillion of high yield debt maturing between now and 2020 according to Standard & Poor’s.  Nearly 60% of this debt was issued between 2012 and 2014 when the average yield on high yield debt was 6.2%. The average yield rose to 8% at the end of 2014 and passed 10% early in 2016 before dropping back recently to roughly 7.7%, but it remains elevated for the weakest credits. There is $280 billion of debt rated B- or lower maturing through 2020 with most coming due (or meeting its maker) in 2019 and 2020, so the day of reckoning may be delayed for a while.

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But when it comes, it will come with a vengeance.

Weak sectors with the largest amounts of debt maturing through 2020 include media and entertainment ($220 bn), oil and gas exploration and production ($112 bn), retail and restaurants ($81 bn), financial institutions ($99 bn), and metals, mining and steel ($44.3 bn).

It will be very surprising if the U.S. economy does not experience a recession (or worse) between now and 2020, and a recession would accelerate the demise of many of these companies. The high yield market benefitted from unusually low interest rates since the financial crisis, but those conditions are coming to an end not because of the Fed’s actions but because the market has repriced risk.

Maturity-Wall-eletter

By 2020, you can expect most of these private-equity-owned retail stores to be bankrupt and closed – and malls across America to see higher vacancies and lower revenues.

Beware The High-Yield Market (But Profit from The Fall)

Successful investors will identify specific companies that can weather the storm: companies with adequate margins of safety to survive a prolonged or sharp economic downturn. And anyone who thinks that a troubled high yield bond market is not a problem for Corporate America is making a serious error.

Investing in ETFs, mutual funds and other broad-based vehicles over the next several years is unlikely to generate satisfactory risk-adjusted returns and could end up blowing up in investors’ faces, particularly since liquidity conditions in the bond market markets are simply awful.

Investors should avoid the fixed income markets until further notice. The Fed has destroyed bonds as an asset class. The biggest bond funds in the world are generating terrible nominal returns. When those returns are adjusted for inflation and the risks taken to generate them (derivatives, leverage, etc.), they are even worse. When they are adjusted for the fact that the currencies in which they are denominated are being actively devalued by central bank policies, they are nothing short of catastrophic for investors. Remember – just because the dollar is strong versus other fiat currencies does not change the fact that the Fed is destroying its value in absolute terms.

Investors need to earn at least a high single digit return to maintain their buying power in constant currency terms. There is virtually no opportunity for them to do so in the fixed income markets except in specific situations such as beaten down high yield bonds such as Sprint Corp. NRG Energy, Toys R Us and fallen angels (investment grade bonds downgraded to junk status) that involve a meaningful amount of risk. (I’ve recommended a fairly low-risk way to play the fallen angels market here.)

While there are a number of individual bonds that are attractive investments for those with patient capital, but the overall market remains a falling knife. In particular, investors should avoid high yield bond ETFs (JNK and HYG), as well as bank loan ETFs and mutual funds, which will continue to underperform as the corporate bond markets remain distressed for the foreseeable future.

Market conditions will further deteriorate as companies confront the need to refinance bonds in an environment where their cost of capital rose exponentially due to the sharp drop in their bond prices. This will spread the pain beyond the troubled energy and basic industry sectors to the rest of the market.

If you own bonds of any of the dying retail companies above – J. Crew, Claire’s, or any of the rest – it goes without saying that you should get rid of them now.

And in order to profit, I suggest that you buy long-dated puts on any one of several mall REITs: Simon Property Group Inc (NYSE: SPG) and General Growth Properties Inc (NYSE: GGP) would both be good choices. Malls are going to be seeing many of their tenants go bust over the next couple of years.

Sincerely,

Michael

28 Responses to “These 6 Retail Companies Are Toast (Get Out Now)”

  1. Charles Roller

    Having worked for a major university endownment fund for 5 years — I am thrilled (maybe wrong choice of words) to read this from you Michael. On so many levels, you are dead on. Question is when the “fit hits the shan” — and it will (I agree with you) — what will be the “clawback” provisions that the bankruptcy courts have at their disposal to go after some of the obvious fee abuses that the hedge fund (and the private equity firms) have inflicted on these “night of the living dead” companies? Don’t worry — I’m not holding my breath – Honest.

  2. I agree with your thesis. With interest rates near zero, equities over priced and a weak job market, there isn’t much to get excited about. Gold/precious metals is one option, but it is volatile. I think shorting some stocks that will be vulnerable is a good idea.

  3. Paul Ellenbogen

    I sell comm real estate all over the country. U r right we have been over retailed in this country for years. Obviously I have not been on every main drag in this country but in most places every store has huge inventory aisles r bursting. I always think rcthere enough people out there to buy all these items? Retailers which I learned many years ago r really banks selling hard/soft goods buying in bulk working on the wholesale retail spread and hoping the consumer buys on time and a hefty interest rate. The old saw of a dollar down and a dollar a week. That has long been the only way most people can afford to buy things ie like a mortgage. What has killed and is killing these retailers is a combination of the Internet and competition. How retailers grow typically is by constantly opening new stores. Why because same store sales are either up marginally or flat. Only the strong survive. Only the best maintained and best located malls will survive and prosper because people still want the shopping experience as they say in the business.

  4. I’m sorry I don’t get the logic. If all these mall stores are going broke why should we invest in Simon Properties or other mall REITs? It seems like they would be in trouble too, with all that vacant space not generation any rent revenue.

  5. Sorry, I don’t get it. If all these mall stores are going broke why should we buy Simon Properties or any other mall REITs? It seems like they would be in trouble too with all that vacant space not generating any rental income.

  6. Gram gold bars? I’d rather not touch them. First the premium, or manufacturing cost is high relative to the intrinsic value. For that reason I stay away. Second, counterfeits of all sorts are out there. It may not be “worth” it to counterfeit a 1 gam bar, I.e. the “profit” would be too small for some one to try to do it. But it also would be expensive to test for authenticity, so finding a buyer might be a problem.

  7. Michael: I love your writing. Looks like all six of the retail stores you warned us about are already delisted 🙂 I couldn’t raise any price quotes on any of them. But your warnings about our hollowed-out economy due to reckless borrowing and more borrowing yet to sustain ongoing deceit is right on target for what’s going to happen to the world economy next. This failing retail stores topic reminds me of all the CNBC complaints against Amazon because they always had ‘razor thin margins’. CNBC was so dull and thick-headed they never saw this is exactly how Amazon makes it impossible for retail stores to compete against Amazon. And the obsolete and ancient belief that big profit margins in retail are a sign of strength are actually blood in the water for that giant Libertarian piranha (Jeff Besos) just carefully waiting to feast on them, and so goes survival of the fittest.

  8. Michael. I did a check on the six retail companies which are toast, and sure enough, neither of my two stock services show any data from them, looking like they’ve already been delisted ?? While I used to be annoyed by Amazon chewing up retail businesses, I’ve now come to experience Amazon as the highest quality, highest integrity retail outlet I’ve ever known. I remember when CNBC disparaged Amazon for having razor thin margins and gave far-too-premature estimates that AMAZON would never survive. Clever as the Libertarian fox that he is, Jeff Besos has single-minded focus on re-shaping retail not only for the USA but for the world as well. Have business policy textbooks yet congratulated Amazon for wiping out all these obsolete and no longer relevant retail entities. They will soon, if they haven’t started already. In combination with the underhanded credit practices you highlight, there will always be a few hungry wolves to thin the herd in a true market driven economy.

  9. Yes!! Retail is in ZOMBIE MODE ..Waling Dead ..In the Investment world, few hit the bottoms and tops exactly..especially in the “manipulated” PM Markets. We are going against RIGGED MARKETS & TERMINATORS> Flash Trading algorhythms that include HUMAN Psychology in their programs!! I Made some moves, preparing for the the fall, but Did begin a buying list of about 15 companies, many I did not get, but still like! I went on a watch mode..In Nov. —- Jan//Feb. I began accumulating some ..not going “All In” TCK, which had a “I missed the Rally” Fake out–up too fast From $4.35 up to the $9 levels, then within a few weeks came quickly down to the $3.25-$3.70 levels at which I Purchased 13 2018 $7 calls ($0.69) & 5 2017 $5 calls @ $53 over a 6 trading day period..missing a 5 hour dip in TCK to $2.75– Oh Well! I Sold 9 of the $7 calls @ $5.00 ea & 4 of the shorter term $5 calls @ $5.75 ea. on May 6th..Sold the last $7 @ $4.60 and and the last of the 2017 $5 calls @ $5.30 — I bought 2 (FCX) I Only got filled on 2 2018 $12 calls @ $1.11 when (FCX) was at the mid $5 .and hit the mid $3’s in two days, during it’s retracement of it’s recent Rapid-Rally, but missed 5 more by 5c on those contracts, when (FCX) Hit the mid $3’s…sold Both yesterday @ $3.70 …that should be My “Meat in the Middle” enough for Me!! ….I Also Purchased 300 sh. of (ASM) @ .88 –Sold Half,150 sh yesterday, @ $1.33 Off the $160 highs ..but still $1.33 ain’t Bad! –Sold (SAND) @ $4.26 Bought 100 (was all over the place in dec.//jan) at $2.22 ..Sold 100 sh of (NG) @ $6.15 I had Bought at $2.96. Bought 8 (HL) 2018 $5 calls @ 0.56 and Sold yesterday @ $1.05 >>>STILL HOLDING 600 sh of (LODE) bought @ $0.36, now $0.42 (a Hold–increasing production–reducing casts)…(GORO) bought 150 sh. @ 1.50 –Sold today @ $3.48 ..FSM bought 100 @ $2.18,. now $6.47 –I’ll lode up, on the next pullback..with patience..Bought (HL) @ $1.53 , now $4.29, Bought 75 sh of (PGLC) @ $3.11, now $3.95..bought 600 (WGPLF) @ ) ($0.13) because of their MGT. past successes..now $0.25 ..also purchased 2,000 sh. of a great little Lithium Mine, (LACDF) in Nevada, close proximity to Elon’s “Giga-Factory”, that has above ground Brines that are 96-98% Purity Rated @ $0.19 a sh —It hit $0.81 a few weeks ago. I put a sell order in to sell half, but missed the peak & it closed at 0.77 with almost 5,000,000 shares traded–“Seller’s Rally” ..I planned on purchasing more @ about 0.47, where it really took off with 2 million sh. volume–but it didn’t hit there (YET!) now at around $0.55!! It appears Monday, the Markets could be down, because of some momentum, at Friday’s close, but I think that, a couple more weak earnings or China “Debt Fears”, could bring traders back to reality–I see a “Head & Shoulders” pattern forming, in the S&P, DOW & PM’s..Sold my 12 SSO Options..bought @ 0.75 and sold at $1.12 the other day…before the 2 day triple digit losses –. never a mistake, Selling at a Profit!! I am accumulating short positions on (CRUS) –8 ,. so far, a Apple supplier,10 7/16 $30 puts @..when I Noticed INCREASED INSIDER Selling between $34 and the upper $36 range, that started somewhat around the $28 area a couple weeks prior..shorted in the Upper $35’s once it peaked the rapid sell was on–falling $1.58 in one day….if the market dives (CRUS) might go to $24 or lower—also the (SDS) $20 Calls –20 so far @ 0.26!!! I sold my 5 GS 7/16 $180 calls @ $2.65 .. I Bought @ 0.83…Markets attempted some FAILED Up moves and some outside manipulations//unseen developments can cause a change, for a bit, I’m very pleased to get pieces from the Sharks we “Swim” with, and their “Terminator” machines!!..On the last 2 Rallies I Bought 16 7/16/ $27 puts on GT @ 0.80, ..8 -8/16 $62.50 puts on DLPH @ $1.60, ..20– 7/16 $22.50 puts on EBAY @ 0.45 & 0.50….7 –6/16 SH 20 calls @ 0.43 …15 08/16 XLF $22 puts …also just bought 15 08/16/ $9 puts on the USO …I was up $768 today on triple digit that probably were not so “FUN” for many. I don’t see much good ahead..except maybe a couple counter rallies, temporarily ..on some data driven flash trades ….but the Charts resemble what we saw at the end of Summer 2015 ..the same “Roll Over” ….SPG ..already is seeing some downside…I’m 70% Cash 30% Invested ..in a somewhat bearish position..but still some longer term longs! ….I also have been accumulating quite a bit of Silver Coins…Eagles, Pandas, Aussies, Canadian..both MS-69-70 .PF 69 – 70 …and TITANIUM, Copper Canadian pennies & 0999 nickel Canadian nickels! Bags of them

  10. Patrick Barnes

    I had been hoping for a continuation of CBK’s breakout in early March. Nice move up, then what seemed like a bull flag, but it’s now clearly failing. Thank you, Michael, for your excellent article sheds light on why this is probably happening.

  11. Patrick Barnes

    Looks like my comment didn’t post. I’ll try again. Michael, thank you for your excellent article. I had been long CBK and was hoping for a continuation of its early March breakout, but the bull flag has failed, and now I think I know why.

    Any comments on IYR? It looked to me like a false breakout last week, so I went tactically long DRV, with a tight stop. I may be wrong, but I note that SPG is IYR’s largest holding.

  12. My comment is in regard to banks that are “Too big to fail”. My government, Canada, is a member of the G7. In his 2013 budget, our Minister of Finance buried a provision on pages 145-146 to use depostors funds in exchange for bank stocks as a bail-in provision a la Cyprus.
    I’m wondering if similar provisions exist in other G7 member budgets around the same time?
    You can confirm this by Googling Canadian federal budget 2013 and search for page 145. I h ave since moved my savings accounts out of our Charted banks over to Credit Unions which are provincially governed.
    There has been very little ink on this, probably news the time to make a stink but nobody seems to care!
    One last question Michael, is June 20 still on or is it a hold for now?
    Thanks for you insight.
    A Canadian investor.

  13. […] As I’ve told you time and time again, the retail industry is in crisis. Buffeted by structural changes such as the explosion of ecommerce, weak consumers and an increasingly selective consumer base, there’s been an epidemic of mall-based retailer bankruptcies lately (Sports Authority, RadioShack, Aeropostale, American Apparel, Pacific Sunwear…) and it’s only going to get worse. I’ve recommended some profit opportunities here. […]

  14. […] As I’ve told you time and time again, the retail industry is in crisis. Buffeted by structural changes such as the explosion of ecommerce, weak consumers and an increasingly selective consumer base, there’s been an epidemic of mall-based retailer bankruptcies lately (Sports Authority, RadioShack, Aeropostale, American Apparel, Pacific Sunwear…) and it’s only going to get worse. I’ve recommended some profit opportunities here. […]

  15. […] As I’ve told you time and time again, the retail industry is in crisis. Buffeted by structural changes such as the explosion of ecommerce, weak consumers and an increasingly selective consumer base, there’s been an epidemic of mall-based retailer bankruptcies lately (Sports Authority, RadioShack, Aeropostale, American Apparel, Pacific Sunwear…) and it’s only going to get worse. I’ve recommended some profit opportunities here. […]

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