By Brian Sozzi
Believe it or not, the characteristics of Greece's economic fallout (high debt due to past profligate spending, chiefly) could be found in the U.S. retail sector. Of course, the default of a retailer on its debt or supplier obligations, or significant restructuring of operations to find wiggle room under a credit revolver, would not trigger the same type of market panic as a Lehman Brothers meltdown or Greece default. In fact, surviving companies would benefit from a major player exiting the scene in its present form.
In searching for Greece stories in retail, I zeroed in on companies that fit at least one of the following qualifications: (1) burdensome leverage on the balance sheet; (2) significant net losses in recent years that have drained cash; and (3) poor future operating earnings outlook, making debt service a risky exercise. The companies that closely align here are Pacific Sunwear (PSUN), Liz Claiborne (LIZ), and Rite-Aid (RAD). Now, unlike Greece, these names are not likely to default (Liz Claiborne/Rite-Aid) on their obligations in the medium-term as a result of efforts to amend credit agreements and extend maturities or not make it to the holiday season (Pacific Sunwear as it does not have outstanding notes). There is the probability, however, that if the consumer fails to show up with consistency and vigor for holiday 2011, execution on merchandising is short of perfection, market volatility sparks a substantial rise in LIBOR, or interest rates rise due to concerns on U.S. debt service that the companies mentioned will experience:
* Inability to access excess availability under credit revolvers.
* Penalizing interest rates on new debt issuances.
* Dilutive equity investments to raise money to fund operations.
* Credit rating cuts by agencies that raise the cost of capital.
The companies profiled are ones that I recommend avoiding as investments suffice it to say. Pacific Sunwear has worked quite well since my downgrade to a sell rating on December 23, 2010 (-55%).
* No operating profits since 2007.
* Operating loss projections: 2011 $82.7 million; 2012 $49.2 million
* 10-K call out: "If the company were to experience a same-store sales decline in 2011 similar to 2010 (-8%), coupled with further gross margin erosion, we believe that our working capital and cash flows from operations might not be sufficient to meet our operating requirements."
* Zumiez (ZUMZ) benefits from Pacific Sunwear store closures or liquidation. Conversely, Quiksilver (ZQK) is harmed as it loses a major outlet for its products.
Pacific Sunwear has a $150.0 million revolving line of credit that can be increased up to $225.0 million, subject to lender approval. As of January 2011, there were no direct borrowings under the revolver and $15.0 million in letters of credit extended. The company's credit agreement is restrictive in my view. With certain exceptions, the company is not allowed to incur "additional secured indebtedness (meaning no note issuance) but can obtain unsecured indebtedness outside of the credit facility up to $150.0 million (equity injection perhaps). Not only is the agreement restrictive, but it seems that dilution to current shareholders from share or option issuances are very possible.
* No operating profits since 2008.
* Entered the year with $22.0 million in cash.
* In negative equity.
* JC Penney (JCP) benefits from funding difficulties perhaps as it buys the Liz Claiborne brand early. Private equity benefits, seeking to purchase Juicy Couture and Kate Spade at attractive valuations.
The company has bought itself some time, first by amending its credit revolver in May 2010 and then by selling a penalizing 10.5% interest rate secured note in April of this year, with proceeds earmarked to pay for a Eurobond tender. Intricacies of
Liz Claiborne's funding structure include:
* All cash collections must be applied to reduce outstanding borrowings under the amended facility should actuality fall below the greater of $65.0 million and 17.5% of the then applicable commitments.
* A breach of the minimum aggregate availability covenant would trigger an "immediate event of default."
* Third largest drugstore chain has not produced a net profit since the February 2006 ended fiscal year (too much interest expense not enough operating income).
* Management has used a combination of debt market access and a new credit facility to navigate the waters.
Rite-Aid has not tapped its new $1.1 billion credit revolver to any substantial degree yet. Still, the company's ability to continue as a concern in its present form is highly predicated on debt market access to roll over maturing paper and successful competition in the marketplace.
If interest rates rise substantially, Rite-Aid could face liquidity problems that might require a disposal of material assets or operations to meet debt and other obligations. For those thinking Wal-Mart (WMT) will buy Rite-Aid, I say they shouldn't bother to incur $6.2 billion in debt. Rather, they should wait for interest rates to creep higher (and they will) which will likely cause Rite-Aid to sell assets on the cheap. Wal-Mart could then go in there with its Express model (putting longer term survival pressure on Rite-Aid) assuming it desires the Rite-Aid locations.