😬Grocers. Grocers. Grossers.😬
|Jan 29|| 28|
💥Retail in 20: New Year Same Old Sh*t (Short B&M)💥
2020 is off to a rockin’ start for retail. The USA Today cites recent figures from Coresight Research that indicate that 1,218 store closures have already been announced in 2020.* This puts 2020 at a run rate of over 12,000 store closures. For the sake of comparison, 2019, which was a complete and utter horror show for brick-and-mortar retail, clocked in at 9,300 announced closures. Many of these closures are occurring in bankruptcy; many are happening to avoid bankruptcy.
Speaking of bankruptcy, here is a not-even-remotely-surprising Fitch Ratings research report indicating that “[n]early half of Retail and Supermarket bankruptcies (25 of 55 cases) were resolved as liquidations, compared with 13% for Fitch Ratings’ universe of cross-sector U.S. corporate case studies. Excluding supermarkets, 50% of Retail cases were resolved via liquidation.” It is paywalled but The Wall Street Journal has a summary here. Said another way, bankruptcy is a death knell for retailers.
We have long argued here in PETITION that “The Amazon Effect” is a lazy and over-simplified explanation for what is afflicting retail today. That there is so much more to it. In no particular order and in no way all-inclusive, there’s (a) greater emphasis on minimalism-rather-than-consumerism, (b) the rise of rental and resale, (c) direct-to-consumer digitally native vertical brands nipping at market share,** (d) bigbox retailers gobbling up foot traffic with loss-leader enticements such as cheap milk that ultimately convert food customers into apparel purchasers (and drive milk manufacturers into bankruptcy —looking at you, Walmart Inc. ($WMT) and Target Inc. ($TGT)), and (e) of course, in many instances, private equity (i) anchoring retailers with obscene amounts of debt, (ii) extracting dividends, (iii) siphoning off valuable real estate through shady sale-leaseback transactions and (iv) taking moonshots with the zombie that’s left.
Interestingly, the same low yields that are boosting the stock market and pumping life into an already-uncanny bull cycle are helping destroy brick-and-mortar retail as we know it. Counter-intuitively too. Low interest rates discourage savings and bolster spending: why save when Chase is paying you 0.1%. Hence, in the face of declining manufacturing and services numbers, the economy hums along as the consumer boosts it with robust spending (and, to a greater degree, the FED effectively engages in another round of non-QE QE). The unquenchable thirst for yield, baby, yield, is pumping money into venture capital and venture capital is pumping money into…well…everything…giving consumers a whole new slate of mission-driven sexy startups to spend their money on.
Nathan Heller writes for The New Yorker:
Once, venture capital was sought by risky startups needing lots of up-front cash, whether for research and development (Genentech had to fund academic-grade research before it had a product to bring to market) or for essential leaps in scale (Uber is appealing only if it’s big enough to get a car to you quickly). Such financing seemed especially suited to proprietary technology, which was expensive, hard to seed into the market, and yet, if things went right, extremely lucrative. That has changed. Since extending its focus to direct-to-consumer retail, venture capital has come to fund delivery services, financial services, car companies, shoe companies, office real estate, leisure real estate, coffee brewers, beer brewers, smoothies, razors, trousers, speakers, scooters, mattresses, toothbrushes, socks, and underwear.
Notably, a lot of that stuff used to be purchased in malls. Today, not so much. He continues:
This realm of direct commerce could be called Venture World. You know what its businesses are like. They appear suddenly, everywhere, with chatty ad campaigns on public transit starring cool, young people who were clearly nerds in high school but who have since mastered impressive dance moves. They tell you that their products aren’t just better; they are simplifying the whole deal, changing how stuff works across society, and not a moment too soon. If you are buying an actual object and live in a major city, you might find a brick-and-mortar storefront decked with ha-ha-clever wallpaper where you can hold the toothbrush of the future or try one of five purportedly game-changing eyeglass frames. But the bulk of Venture World’s offerings are online, where they are hawked on bright, uncluttered sites that scroll down, down, and down again with charming animations, offering moving stories about one big idea that will change the industry, about community, about zero-impact supply chains, which, thanks to their backing, they can afford. In Venture World, everyone seems to be more or less on your wavelength. Its companies are geared toward unfussed people who keep their phones silenced and close. Venture capitalism is behind most of the platforms on which people lament the gaucherie of “late-stage capitalism”; it has become the chief industrial backer of the self-aware, predominantly upper-middle-class approach to life style now called woke.
Why hop in a car, waste gas circling around in search of parking, enter a mall and suffer the indignity of walking into a Victoria’s Secret and dealing with an unknowledgeable salesperson when you can just order your lingerie online, try it at home, get the opinion of your partner, and, if no-go, ship the order back? For free.
Know that you need to get that new bra but don’t have time to head to the store because you’re billing 16-hour days? Those venture-backed DTC companies will remind you by bludgeoning your inbox and your wallet into submission.*** Per ModernRetail:
Once direct-to-consumer brands get you to click on their Instagram ads, their next goal is to take over your email inbox.
Kristen LaFrance, head of growth and community at Churnbuster, a company that helps subscription providers recover failed payments, detailed receiving 24 emails in 65 days from DTC sock brand Bombas. Outdoor Voices and Casper sent 43 and 44 emails respectively between July 1 and September 25 according to retail consultancy Loose Threads, which tracks how many emails retailers send by signing up for their email list.
Talk about going where your customers are: most professionals are in front of screens and in their email inboxes. Old school retailers are fighting with one arm tied behind their backs. As any restructuring professional knows, most of them have gawdawful data. Like, REALLY bad. Good luck sending 4,292,119 marketing emails a week PER INDIVIDUAL like some of these DTC companies do. 😜
The situation is bad and only getting worse. This recent report from Euler Hermes Global is stupefying.
At first glance, the U.S. retail industry is the typical case of what the Austrian economist Joseph Schumpeter called “creative destruction”, in which new entrants capture growth or create new markets altogether at the expense of established companies. In the long run, creative destruction is supposed to have a net positive impact on the economy; however, judging from figures pointing to shrinking company count, employment and profitability, e-commerce isn’t compensating for the destruction of physical retail.
This much is obvious. But wait. It gets worse:
The U.S. has lost more than 56,000 stores, or 10.7%, of its discretionary retail footprint since 2008, despite healthy spending on discretionary consumer goods. Employment data depict a similarly gloomy picture, with 670,000 net job destructions since 2008 (-9.6%). For one job created in e-commerce, four and half jobs are lost in traditional discretionary retail.The segment breakdown shows a broad-based decline largely consistent with e-commerce penetration, which is the highest for hobby goods (toys, books, music and video content, etc.). Shoppers’ growing taste for online orders has also hurt shopping mall footfall and department stores, which reported the sharpest decline in employment (-24.5%).
Remember: the period that they’re talking about is the longest bull run in history.
We observe a clear surge in large retail insolvencies since 2015, involving more than USD45bn in liabilities. High-profile insolvencies are also telling of a broad erosion of profitability.Drawing on a panel of 127 U.S. corporates, we find that one in 10 listed retailers has gone bankrupt since 2008, and that another 41% have seen a decrease in profit margins, especially in the department store, discount store and clothing store sub-segments.
Faced with declining profit margins, many of these retailers are pivoting towards…wait for it…e-commerce. Which has notoriously poor margins. How does this possibly end well?
As a “winner-take-most” business, e-commerce revolves around a limited number of companies. Leaders have a commanding share of sales, and more importantly, of profits. The shift from offline to online has had a net negative impact on company count, retail employment and profit distribution. For all its top-line growth, e-commerce displays the lowest median profit margin of all segments. The adoption of new business models also carries inherent transition risks. Moreover, e-commerce has seen few successful new entrants: Between 2008 and 2019, e-commerce accounted for only eight out of 47 newly listed retailers. New entrants display the lowest profit margins and only three of them were cash-flow positive in fiscal year 2018.
Equities have traded accordingly. At the time of this writing, Revolve Group LLC ($RVLV), an online fashion accessories retailer, is trading 2% below its IPO price and 50% below its first day close; Chewy Inc. ($CHWY) is up 29.4% from its IPO brice but down nearly 20% from its first day close; and TheRealReal ($REAL) is off 22.5% from its IPO price and nearly 50% from its first day close.
So what’s going to happen here?
We expect further e-commerce penetration and heightened competition to eliminate over 500,000 jobs and 30,000 establishments by 2025. All segments, except beauty and cosmetics, will see substantial cuts in physical retail capacities with apparel, electronics & appliances, as well as department stores, facing the biggest challenges. This would represent a significant acceleration from the pace of destruction observed over the past few years. Additional bankruptcies of large retail chains are inevitable and will be instrumental in reducing the U.S. retail footprint: We anticipate the highest default risks for large corporates in clothing, footwear & accessories stores, as well as department stores. Furniture and home furnishings stores are also likely to see a deterioration of credit metrics as competition heats up.
But the destruction won’t end there:
For consumer goods companies supplying discretionary retailers, growing e-commerce penetration will not only translate into heightened non-payment risks, but also a further concentration of their retail mix. Retail consolidation could in turn have an adverse impact on their bargaining power and profitability. Incumbent retailers also face the threat of growing competition from their own suppliers.
IN CASE YOU FORGOT: WE’RE IN THE MIDST OF THE LONGEST BULL RUN IN HISTORY.
All of this destruction is also scaring away potential strategic buyers. In its “US Consumer Markets deals insights: 2019 recap and 2020 outlook,” PwC notes:
Despite Retail deal investments improving in Q4 2019 to reach its highest quarterly value since Q2 2018, overall transaction value in 2019 declined by 28% over the past year. Dwindling M&A activity in the sub-sector is attributable to several factors including: disruption from e-commerce players and increased competition from resale and rental services; creating in-store experiences to keep brick-and-mortar relevant, particularly among younger generations; maintaining proper inventory management across all sales channels and ensuring merchandise flow; low unemployment levels and rising labor costs; tariff and trade disputes.The largest Retail deal announced in 2019 was the $16.2 billion pending acquisition of Tiffany & Co. by LVMH, which accounted for 58% of total Retail investments in 2019.
This pain will reverberate throughout retail and, eventually, the destruction will hit many a venture-backed DTC portfolio company too. And then funding will dry up and a lot of companies with piss poor unit economics will drown. It’s only a matter of time. What will be left? Walmart, Target and Amazon.
Of course, we’re supposed to believe that this will only affect the lower tiered malls. 🤔
Spoiler alert: malls don’t buy their tenants unless they fear more pain to come (see Forever21). If that narrative holds true, they also shouldn’t get downgraded to a “B” rating when the majority of the portfolio is allegedly “Tier 1.” But that’s exactly what happened to Washington Prime Group Inc. ($WPG) this past week. Fitch Ratings declared:
The downgrade reflects Fitch's views of increasing headwinds in brick-and-mortar retail and WPG's high exposure to the deteriorating performance of department store anchors and apparel and commodity retailers. WPG's operating metrics have worsened to a degree that Fitch believes may require collateralizing of its credit facility absent material improvement in the next 12-24 months. The company's FCF profile (cash flow from operations less recurring capex and common dividends) weakened to negative territory in FY19 and Fitch anticipates WPG will need to cut its dividend to generate positive FCF in FY20.
Ah, that’s probably nothing. We’re sure everything will be just fine.
*This number includes the recent closure announcements from Papyrus (now bankrupt) and Express Inc. ($EXPR) (tick tock, tick tock) but may exclude these closures by Gap Inc. ($GPS).
**Despite, some might argue, adding no value whatsoever. This piece, for instance, is BRUTAL in its epic shade-casting on DTC companies.
***The volume of DTC companies out there competing for your mindshare and walletshare has gotten so intense and confusing, that a derivative response has been the rise of review sites so that you can make sense of it all.
🍎Another Day Another Bankrupt Grocer (Short Food)🍎
In Sunday’s Members’-only a$$-kicking briefing entitled “🔥Like No Other Newsletter🔥,” we took a deeeeeeeeep dive into the Fairway Group Holdings Corp. chapter 11 bankruptcy filing. We relegated to a mere footnote, the following:
*Two more local grocers to watch out for: Lucky’s Market (not PE-backed) and Earthfare (PE-backed). The former announced, on the heals of losing its sponsorship from Kroger Inc., that it would close 32 of 39 stores. The latter is quietly shuttering stores (e.g., Gainesville and Indianapolis). This is telling:
“Stern said Lucky's could potentially be acquired, but he said logical choices like Sprouts Farmers Market and The Fresh Market are also retrenching and not in expansion mode right now.”
The pain in grocery is pervasive.
Lucky’s Market Parent Company LLC be like:
And so the Colorado-based company and 21 affiliated entities filed for chapter 11 bankruptcy in the District of Delaware. Because, like, f*ck it: the pain in grocery IS pervasive so it might as well become a chapter 11 debtor like everyone else.
This one swims upstream. The debtors focus on affordable organic and locally-grown produce, naturally raised meats and seafood, and fresh daily prepared foods. Which, we thought, was supposed to be all the rage. “Organic for the 99%” was their mission. They even have private label goods. AND they have a millennial-pleasing “giving” element to their business: 10% of profits from private label sales are reinvested into the local communities they service. They have no unions. And they’re not even private equity owned!! Kroger Inc. ($KR) is the debtors’ secured lender and largest equity holder and, while obviously not PE bros, it seems that maybe(?) Kroger pushed the Colorado-based founders to grow too fast too soon?? In the midst of a number of grocery bankruptcies to boot. In April 2016, they had 17 stores. The Kroger transaction took place at that time and then — BOOM! — a private equity growth mentality appears to have mysteriously overtaken the debtors. By the end of that year, the debtors’ footprint was up to 20 stores; by the end of 2017, it was 26 stores; 33 stores by the end of 2018; and 39 stores by the end of 2019. Florida was a primary focus.
The timing was pretty bad. Per the debtors:
…the Company’s expansion in Florida coincided with, among other things, increased competition in the grocery industry, including expansions from competing chains such as Sprouts Farmers Market, Fresh Thyme Farmers Market and Earth Fare. As a result, notwithstanding the growth in sales, the portfolio of Company stores was unable to achieve sustainable four-wall profitability.
Note the mention of Earth Fare ⬆️. Get ready for Dirty Dancing 2: Havana Nights gifs, people.
Most recently, fiscal year-to-date through January 4, 2020, the Company had approximately $22 million of store operating losses and approximately $100 million net loss. Additionally, fiscal year-to-date through the week ended January 18, 2020, the Company had a 10.6% reduction in comparable store sales versus the prior year-to-date period.
Suffice it to say, that growth strategy diiiiiiiidn’t work out so well.
And so now it’s all being unwound. The debtors began winding down 32 of their 39 stores pre-petition and, obviously, terminated plans for 19 leased but unopened locations.
Absent closure, the debtors note, they’d be on the hook for $30mm in operating losses for fiscal year ‘20. Now they’re selling furniture, fixtures and equipment from, and transferring leases of, 26 stores to third-party purchasers. They have an asset purchase agreement with Aldi for six FL locations and Publix for another 5 while they continue to operate 7 locations while the marketing process progresses.
The debtors will use Kroger’s cash collateral to fund these cases.
Please note that one of our favorite events is coming up: the 16th Annual Wharton Restructuring and Distressed Investing Conference is on February 21st at The Plaza Hotel in NYC. The Conference offers a great learning and networking opportunity for industry professionals and those interested in investment banking, operational/ turnaround consulting, and private equity and hedge fund investing.
Howard Marks (Co-Founder of Oaktree Capital), Mark Brodsky (Founder of Aurelius Capital), and Judge Shelley Chapman (Southern District of New York) will keynote. There will also be a variety of different panel discussions. Tickets are available here and more information here.
Please note: we have two free passes available to lucky PETITION Members. Please email us at email@example.com, note “Wharton Tix” in the subject line, and let us know one subject area that we should be focusing more attention on (and why) and you’ll be entered to win one of the free passes. Cheers.
We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. One recent addition to our list — which, to be clear, we haven’t yet read, is “The Longing for Less: Living with Minimalism” by Kyle Chayka. Here is a NYT review of the book. It sounds interesting and appears to address yet another headwind confronting businesses with wares to sell to consumers apparently reacting negatively to consumerism for consumerism’s sake. Per the NYT:
But those two kinds of minimalism — sleek lifestyle branding and enforced austerity — don’t quite convey the enormousness of the subject Chayka explores in this slender book. Delving into art, architecture, music and philosophy, he wants to learn why the idea of “less is more” keeps resurfacing. He sees it as a shadow to material progress, a reaction to abundance, a manifestation of civilization’s discontents.
To the extent this is a “movement,” what ramifications will it have? How are all of the recent macro numbers suggesting the “strength of the consumer” reconcilable with the notion that minimalism is a growing trend? This is worth learning more about and watching.
Alex Boerema (Manager) joined CR3 Partners (Chicago).
Cade Kennedy (Director) joined CR3 Partners (Dallas).
Sean Cunningham (Partner) joined CR3 Partners (New York).
Ben Browne, Kate McGlynn and Patrick Widmaier on their promotion to Managing Director at AlixPartners.
David Tiffany on his promotion to Partner at CR3 Partners.
Layne Deutscher on his promotion to Manager at CR3 Partners.
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