PwCCF Capital Markets Flash: Industry Flash

Volume 2, Issue 3: January 23, 2009 — Retail Industry Supplement


Welcome to the PwCCF Industry Flash — a supplement to our regular Capital Markets Flash publication.


This free, bi-weekly email news alert from the PwC Corporate Finance practice provides an overview of recent notable events in a particular industry, as well as PwC perspectives to help organizations better manage in a downturn.

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In this issue: Sales abound... shopping carts empty?

“The winter of our discontent” (Richard III, Shakespeare)

North American retailers are reeling on the heels of one of the worst holiday shopping seasons in decades. The US Commerce Department estimates that December retail sales plunged 2.7%, a record sixth consecutive monthly decline and significantly worse than expectations of a 1.2% decrease. Similarly, Statistics Canada reported on January 22, 2009 that Canadian November retail sales fell 2.4% from October, the largest monthly decline since January 1998.

“All that glitters is not gold” (The Merchant of Venice, Shakespeare)

As anticipated, American consumer necessities retailers, including supermarkets and pharmacies, have suffered much less than their discretionary goods counterparts, including apparel and home furnishing retailers, which witnessed average declines for the month of December of 13% and 7%, respectively. Luxury retailers, such as Tiffany & Co., and many major US department store chains including Saks, Nordstrom and Neiman Marcus have been hit hard reporting same store declines in year over year holiday sales of more than 20%. Even moderately priced retailers such as Abercrombie & Fitch, Pacific Sunwear and American Eagle Outfitters reported double digit negative same store sales.

New crisis extremes are continually being set

Barometer
PwC Retail Barometer: Extreme

 
Current1 Crisis Extreme Start of Crisis2 Pre-Crisis Extreme3 Trend
S&P Retail Index
 1,011.4 762.9 1,649.2 1,356.3 down
Canadian CPI Index
 114.1 114.1 115.7 N/A down
Unemployment Rate – Canada
 6.6% 6.6% 6.2% 6.2% down
Unemployment Rate – US
 7.2% 7.2% 6.1% 7.5% down
Consumer Confidence – Canada
 67.7 67.7 85.7 79.6 down
Consumer Confidence – US
 38.0 38.0 61.4 51.0 down

O Consumer, Consumer! Wherefore art thou Consumer? (Adapted from Romeo and Juliet, Shakespeare)

  • American consumer borrowing dropped 3.7% in November 2008 – additional evidence that households are unwilling or unable to take on more credit. This represents the biggest percentage decline since 1998.
  • The Conference Board of Canada predicts that personal income will post only modest growth of 2.1% in 2009, significantly shy of the 4.8% pace registered in 2008.
  • Nearly 2.6 million jobs were lost in the US in 2008, with 1.9 million destroyed in the last four months. As a result, unemployment rates in the US hit a 16 year high. Canadian unemployment rates also climbed steadily, as 105,000 Canadian jobs were lost in the final two months of 2008.
  • These factors, in conjunction with the data below, continue to have a significant impact on consumer spending, and have driven the North American retail market into a tailspin.
North American Unemployment Rates North American Consumer Confidence Index
US Consumer Debt Ratios Canadian CPI Index

“What’s gone and what’s past help” (The Winter’s Tale, Shakespeare)

It’s bankruptcy season

  • The number of North American bankruptcies increased significantly since the second half of 2008 and included high profile retailers such as Circuit City, Goody’s Family Clothing, Gottschalks, KB Toys, Lenox Group, Mervyn’s, Steve & Barry’s and Linens ’N Things.
  • Canadian subsidiaries of US companies, such as The Source by Circuit City and Linens ’N Things, are being dragged into bankruptcy despite their profitability as their US parents file for Chapter 11 protection. These Canadian subsidiaries are often tied to their parent’s credit agreements, have heavily integrated supply and distribution arrangements, and are dependent upon head office resources and buying power from the larger operation.
  • Given the current retail environment and lack of available credit, a number of these recent US bankruptcies are being forced to liquidate rather than restructure.
  • Even sophisticated turnaround private equity firms, such as Sun Capital Partners (Mervyn’s, Sharper Image, Wickes Holdings and Lillian Vernon) and Prentice Capital Management (Goodys, Whitehall Jewelers, KB Toys and Levitz Furniture), have seen their large retail investments, many of which were saddled with large debt obligations, file for bankruptcy. Other retail investors are spending millions to alleviate liquidity issues for portfolio companies, such as NRDC Equity Partners’ recent capital injections of $60 million and $70 million to Lord & Taylor and Hudson’s Bay, respectively.

Retailers are cutting spending across their operations

  • In order to improve profitability and right size their business, many retailers are closing targeted locations. Canadian retailer Fairweather, announced plans to vacate their flagship Eaton Center location at the expiry of the lease in February. Laura Secord closed two locations with plans to close two or three more. US retailers Macy’s, Cost Plus, Ann Taylor, Charming Shoppes, and New York & Co. are also among a growing list that has announced intentions to close targeted locations.
  • Other retailers have announced widespread job cuts in order to scale back operations, including Sak's (1,100), Best Buy (500), Walgreen’s (1,000), and Williams-Sonoma (1,400, equal to 18% of its full-time workforce).
  • In an effort to boost sales and move inventory, many companies are offering deep discounts on in-stock merchandise despite the negative effect on margins. Heavy discounts may set a dangerous precedent for consumer expectations into 2009.
  • Consumers’ ability to buy is being impacted as credit card issuers are offering fewer new cards and cutting credit limits. Overstock.com and Buy.com are among the online retailers offering additional ways to pay, such as the PayPal service, so that consumers can complete their purchases.
  • Responding to consumers’ increased need for credit terms, many leading retailers, such as Sears, Buckle, Kmart, TJ Maxx, Marshalls and Burlington Coat Factory, announced year-round layaway programs.

There is a tide in the affairs of retailers (Adapted from Julius Caesar, Shakespeare)

The impact of disappointing retail results has already been felt by other industries

  • Many retailers are cutting advertising spend as a first line of defense. Some experts have forecasted a 10% decline in ad spending, which represents the steepest decline in decades.
  • Commercial real estate is feeling the effects of store closures and bankruptcies. A number of companies are attempting to off-load leases for closed stores, but the slump in the real estate market is making this very challenging. Circuit City alone will be closing 567 stores in the US as it begins to liquidate. Delinquency rates on commercial mortgage backed securities have nearly doubled in the past three months to 1.2% and are expected to climb to 3% by the end of 2009.
  • Apparel manufacturers are expected to suffer alongside retailers as steadily weakening retail sales have decreased demand for their product. Early earnings warnings by apparel manufacturers, such as Coach, Liz Claiborne and VF Corp., have already been issued.

“True it is that we have seen better days” (As You Like It, Shakespeare)

The promise of a New Year, or the beginning of a long slide?

  • In general Canadian retailers fared better in 2008 than their American counterparts. Some Canadian apparel retailers have even seen positive results from late 2008, such as West 49’s 1.7% increase in sales for the holiday season. Pharmacies, personal-care and food-and-beverage retailers experienced sales increases of 0.5% in November.
  • Some American organizations are asking for stimulus packages for the retail segment that may include incentives like sales-tax holidays, providing a direct benefit to consumers.
  • The Conference Board of Canada predicts muted inflation and expected tax rebates will help bolster real after-tax income, permitting households to increase real spending by 1.7% this year.

But...

  • The Conference Board also predicts total employment in Canada will drop by 0.7% and boost the country’s unemployment rate above 8% by the end of 2009.
  • The US National Retail Federation projects 14,000 store closings in 2009—more than double the total for 2008.

Suggested Actions – Retail Performance Improvement Formula

  • Evaluate store ROI and benchmarks – develop and implement a rigorous process to measuring store profitability and identify under performing store locations.
  • Implement effective management of merchandise margins and inventory performance – introduce strong management of markdowns through the merchandise life cycle, tight control over merchandise open-to-buy levels and control inventory levels in line with forecast sales.
  • Examine total cost infrastructure – analyze and address all store, distribution center and corporate costs.
  • Focus IT spend on the most critical projects to drive earnings and cash flow. Discretionary spend has no place in this economy.
  • Invest in customer interactions – focus on building customer satisfaction and loyalty.
  • Access stranded capital – consider selling non-core assets and evaluate sale-leaseback opportunities.

PwC Happenings

In October 2008, Karabus Management, a leading retail advisory firm, became part of PwC Canada. Karabus, through its 50 dedicated retail consultants, helps retailers significantly improve their operational and financial performance. Karabus and PwC have been retained in 2008 and 2009 to assist numerous Canadian retailers combat the effects of the economic downtown. To learn more about Karabus, please visit www.karabus.com.

Notes:

Sources: Bloomberg, Statistics Canada, Bureau of Labor Statistics, Conference Board of Canada, US Conference Board

  1. Current Data is most recent available information: S&P Retail Index at January 23, 2009; CPI Index at November 2008; Unemployment Rate and Consumer Confidence data at December 2008.
  2. Start of Crisis data is most recently available information after September 1, 2008: S&P Retail Index at September 2, 2009; CPI Index, Unemployment Rate and Consumer Confidence data at September 2008.
  3. Pre-Crisis Extreme includes last 5 years of data before September 1, 2008.

Sources: Bloomberg, Reuters, The Financial Post, Federal Reserve, Bank of Canada, Conference Board of Canada, The Globe and Mail, Wall Street Journal, New York Times, The Associated Press, The Washington Post, Internet Retailer, Retail Council of Canada, TNS Retail Forward, Business Week, Financial Times, Internetretailer.com, MarketWatch, company press releases.