Make or Break Retail

The weekend before last, my wife and I ran an errand that took us to our local mall.  We were surprised at what we saw.  Here we were, a week before Thanksgiving, and one of every four small store spaces was empty.  Foot traffic was also light and you could shoot a cannon down most halls and not hit anyone.  Of anytime, I would expect the mall to have its shops full, at this time of the year. 

Now not every place in our town has retail that suffers.  One of the newer shopping areas with an attractive outdoor mall continues to grow with new stores, restaurants, and hotels going up there.  But malls seem to be suffering.  Ours has two large walking dead retailers of JC Penney and Sears that are anchor tenants.  A large space has been taken up by a franchised gym.  A church rents mall space as does some federal government offices. 

Times are changing.  We have looked at three different malls so far, this year and passed on all three.  There is a so-called retail apocalypse concept that now even has its own Wikipedia entry!  The industry’s response to this is typical media fearmongering that stresses only the troubles in the industry and not the good. 

There are some bright spots in retail.  In the first three quarters of 2017, retailers announced 3,044 more openings.  Twenty seven of the 50 states have more retail jobs today than they did in January 2007.  Four of those states, North Dakota, Texas, Washington, and Utah, even have double digit increases in retail employment.  And if you have a strong online presence, more people are shopping that way every day.  Personally, our family used to run out during the Thanksgiving weekend to do Christmas shopping.  It was an event where we used to get up early on Black Friday to hit the stores.  Now most of our shopping for Christmas is done on line.  I would guess many others are this way as well.

Bloomberg posted an interesting article earlier this month on America’s Retail Apocalypse.  There appear to be more dark clouds on the horizon for retail.  Compared to the 3,044 new store openings, 6,752 stores (excluding grocery and restaurants) announced closings in 2017.  This also comes at a time of high consumer confidence, unemployment at tremendously low levels, and strong hope for future economic growth.  These are historically times when retail will boom.  And yet, we see more closings, chains filing for bankruptcy, and stressed retail debt than during the financial crisis.  In metro areas like Reno, Phoenix, inland Southern California, Denver, Kansas City, St Louis, Detroit, and southern Louisiana, retail restate loans have delinquency rates exceeding 10%.  Pittsburgh leads the nation with 26.8% of all retail real estate loans late. 

The root cause is not as easy as blaming Amazon or other online marketers.  It is not 20-40 year olds spending more money on experiences than things.  Bloomberg puts the root cause as high debt.  Many of these long-standing companies are overloaded with debt.  Many of these are from leveraged buy outs from private equity firms.  These billions of dollars of debt are going to be harder for even healthy chains to sustain. 

What even makes this harder is that much of this debt is coming due.  This year, only around $100 million of high-yield retail debt came due.  This will increase to $1.9 billion in 2018 according to Fitch Ratings.  From 2019 to 2025, each year, the retail debt balloon will average $5 billion each year.  Even worse is the market for high yield debt will hit a record $1 trillion for all industries over the next five years.  So, the retail debt balloons will come in a time when demand for high yield money is high.  Also, don’t forget that with the Fed raising interest rates, some high yield seeking investors will gravitate toward lower risk alternatives that now pay more.

A canary in the coal mine may be Toys “R” Us who surprised investors by filing for bankruptcy in September 2017.  Typically, one would think you would wait until the Christmas season is complete, but Toys was struggling to refinance just $400 million of its $5 billion of debt, even though the company had stable results with increasing profits during a time when there was a small drop in sales.  Another testament to the negative aura of retail was earlier this year when Nordstrom’s founding family tried to take the department store private.  They gave up because lenders were asking for 13% interest was the best deal they could come up with. 

Note that on this retail real estate debt, an entire third is financed with local and regional banks.  Nearly a quarter is in the CMBS market, 15% is with national banks and 13% is with insurance companies.  Any amount of tremendous stress will hit smaller banks hard. 

The ripple impact of the stressed debt will hit employment as retail is the largest employer of Americans at the low end of the income scale.  Salespeople and cashiers make up 8 million jobs in the U.S.  During the financial crisis, 1.2 million retail jobs disappeared from 2008 to 2009.  Since 2010 employment in retail has grown each year except this one when 101,000 jobs were lost.  Low end retail jobs often provided a starting point where workers could move up to managerial positions and make an entire career in retail.  My father was one of those who did this. 

This drop in employment matches an acceleration of store closings with bankruptcies and larger retailers deciding they have too much space.  This is the position of Wal Mart and Target.  Note that the drop of 6,752 stores in 2017 is close to the all-time high of 6,900 in 2008, during the financial crisis.  Apparel chains have taken the largest hit with 2,500 locations closing.  Department stores of Macy’s. Sears, and JC Penney have downsized to around half of their total space of a few years ago.  The decrease in retail real estate has been stronger in rust belt and New England states. 

We all see the negative state of retail today, just as my wife and I did walking through our local mall.  Today will be good times in retail as we remember them, if the coming retail catastrophe hits.