-- ABL Advisor : July 10, 2017
BankruptcyData recently released statistics that over 300 retailers have filed for bankruptcy to date this year. To substantiate this trend, a recent report from Credit Suisse estimates that over 8,600 retail stores will close by December 2017, perpetuating a retraction that will lead to 20%-25% of the nation’s 1,100 shopping malls being shut down over the next 5 years.
There is no shortage of chatter about the current retail downturn, particularly surrounding the impact of the online marketplace, the frequency of well-known stores being shuttered, and options for repurposing retail shopping centers. However, what is often missing in the conversations is the effect of the correction on inventory, particularly how pricing and value are adjusting as rising surpluses channel through the marketplace.
As retail pricing becomes more individualistic and dynamic and as factors that affect demand fluctuate, disruptions are having an overwhelmingly adverse effect on retail that is fueling the flood of store closings. This massive disruption is being coupled with online review platforms that drive customers to buy off-brand, cheaper merchandise that meets their needs better than name-brand goods sold at full price. As name-brand firms that require profitability to pay for overhead compete with low-profitability firms driven by high inventory turns from discounted pricing models, online and omni-channel firms with discounted prices and shopping convenience are winning.
The effects of the shift have proven to be exponential with no end in sight. In the short-term surplus inventory from large retail chains shuttering stores will potentially flood the market with discounted goods as more liquidations occur. How short is unpredictable. However, there is anticipation, or perhaps hope, that it will taper down as ordering cycles catch up and inventory orders scale down for the firms that survive the correction. Alternatively, the trickle-down effect could cause a pronounced increase in store closures through a continued retraction. If the market suffers from soft sales in the third and fourth quarters, the carnage through next year or longer could be debilitating to the industry.
What also is not known is the inflection point where large retailer’s and online retailer’s disruptions overwhelmingly affect the smaller retailers that make up 91% of the sector. Signs of the trickle-down are surfacing as some small retailers seeking exit strategies are finding that intermediaries are turning them away due to little to no earnings and little to no market for purchasing retail businesses. For those that are ultimately faced with liquidation in a market full of discounted merchandise, recovery rates could be dramatically affected.
Price Suppression Reigns Because typical buying cycles are 6 months to a year out, as the retraction is moving at an exponential pace, retailers are becoming progressively more challenged with effective ordering. This is tying up cash and driving the surge in surplus merchandise. When combined with customers being retrained to wait for sale seasons, the effect has led many retailers into perpetual sale cycles that are suppressing prices and diminishing profitability. Some retailers are responding by carving out entire sections of their stores to promote heavily discounted merchandise, while other large retailers are expanding outlet store locations, some of which have a larger footprint than their standard retail presence.
Off-price chains are also thriving and playing their part in price adjustments. With the increased supply of discounted inventory in their supply chains and a broadening customer base demanding low prices, off-price chains have been able to expand their market share rapidly. In fact, TJ Maxx has had sales increases for stores open at least a year for 33 straight quarters and plans to open an additional 250 stores in 2017 by taking advantage of bargains on spaces other retailers have closed. Similarly, Dollar General plans to increase their brick-and-mortar footprint in 2017 by 1,000 stores.
It remains to be seen if outlet growth or off-price chain growth will have a positive net effect on the retail sector particularly as liquidations purge excess inventory, overstocks begin to level off and inventory ordering becomes more efficient. Aggressive expansion strategies that have backfired on retailers are arguably fueling the current contraction.
Alternatively, as more retailers and shoppers continue to move to online platforms, it could be argued that online shopping is single-handedly suppressing inflation through disruption of equilibrium prices. Led by a pricing model that drives an 7x inventory turn rate with little to no profitability, Amazon is leading the charge by allowing merchants to utilize comparative pricing tools to encourage keeping prices competitive and drive product from the shelves. Prices can get low enough that even liquidation sale shoppers will continue to compare prices online while visiting liquidation sales.
The Effect on Lending Though not immune to the correction, so far commercial lenders appear to be in the clear, particularly those with marketable advance rates on inventory. Research shows that manufacturers and proactive inventory supply chains have been quick to make vertical integration adjustments to shorten turnaround times in order to achieve greater flexibility with reduced surplus stock. They are actively adjusting to meet demand, are effectuating “fast-fashion” type models, or are unloading stock to their retail customers at discounted prices to move inventory off their own shelves.
Many retailers are equally responding with effective scalability measures, paring back poor-performing stores and developing effective omni-channel presence. To date there is no overwhelming evidence that inventory valuations are on the decline and recovery rates are compromised. What remains to seen is the number of investable businesses that will ultimately be purged in the correction as competitive pricing models further drive down the prices of inventory and perpetuate surpluses that must be sold quickly at discounted prices.