Taking Stock of Retail’s Reversal of Fortune
By: Michael McGrail
Those who run retail liquidations have had to continually shoot down a popular misconception over the past couple of years that “you must be incredibly busy right now.”
The mistaken assumption is based on the thinking that retail bankruptcies have exploded since COVID-19 as things were terrible during the lockdowns and now everyone shops online. However, the true “retail apocalypse” was in full swing before the pandemic upended life in the United States. For example, in 2018 and 2019, there were filings and/or liquidations by major brands like Toys ‘R’ Us, Claire’s, David’s Bridal, The Bon-Ton Stores, Payless Shoesource, Shopko, Diesel and Gymboree. At that time, appraisal and disposition firms hired hundreds of people to close thousands of stores across the United States.
Why didn’t the COVID-19 pandemic trigger something worse than what occurred in 2018 and 2019? A raft of supportive factors came together to keep retailers in business and out of bankruptcy court during the first few years of the COVID-19 pandemic, including unprecedented rent concessions from landlords, hundreds of billions of dollars in government relief money and even the stimulus-abetted “Great Resignation,” which bolstered margins by keeping payroll costs down when product was in short supply.
Despite this tremendous support, if we fast forward to today, we unveil a head-spinning reversal of fortune for many American retailers. Rent concessions have subsided, stimulus money is gone, and shelves and stockrooms are now over-inventoried. The costs of shipping, processing and storing returns are such that some retailers are considering so-called “just keep it” policies with customers receiving refunds for certain unwanted items with no obligation to send them back.
Meanwhile, Americans are pulling back on non-essentials as the Fed continues its tough fight against inflation. “Looking ahead to 2023,” McKinsey notes in a December 2 report, “retailers face headwinds from inflation, rising interest rates, and increasingly pessimistic consumer sentiment.”
Against this new backdrop, asset-based lenders should pay even closer attention to what’s happening with retail borrowers’ inventory.
After a false start of sorts, the United States may experience an acceleration of retail bankruptcy filings and liquidations in the months ahead. However, by being proactive about inventory efficiency, lenders can better position themselves and their borrowers to cope with the volatility. Here are three potential areas of focus:
Put E-Commerce Under the Microscope
Ramping up online sales was a natural response to COVID-19, but some retailers have embraced a questionable all-or-nothing mindset. For example, one national specialty chain shuttered hundreds of brick-and-mortar locations to go internet only. Counterintuitively, online sales decreased in the absence of the stores for this retailer and further analysis indicated that a significant percentage of online sales were attributable to shoppers who had visited a store.
Additionally, there is a heavier drag on performance given the higher costs of promoting and processing returns and shipping and storing merchandise. Inevitably, much of this “shopworn” product ends up in glutted secondary-market bulk bins, making margin erosion a real risk.
The high cost of acquiring new online customers is another challenging component and one that some retailers fail to fully appreciate. One $200 million retailer evaluated by Tiger Group was spending most of its resources on top-line e-commerce growth. Initially, the chain had spent $10 million to acquire $40 million in sales. However, the company burned through about $30 million to pick up its next $10 million, an unsustainable growth model that calls to mind the old line “volume over profit.”
None of this is to suggest that brick-and-mortar retailers should avoid selling goods online. The goal should be to sell for a reasonable net margin. In working with these types of borrowers, lenders should do the math on e-commerce and investigate whether borrowers are taking a balanced approach that maximizes margin.
Get Granular About What Retailers Sell
The new economic landscape merits a more granular look at retail demand. To better understand a borrower’s position, lenders should take maximum advantage of the consumer data available to them, both from appraisal and disposition firms and market researchers. Tiger, for one, uses an analytics engine to sift through millions of e-commerce and other transactions, a valuable tool for tracking trends and benchmarking.
Blanket generalizations—i.e., “grocers are resilient because people have to eat”—aren’t enough. Consider Deloitte’s recent food-sector survey of 2,054 American adults. Published this past September, the research showed that nearly half of these consumers (46%) reported buying fewer expensive items. Other shifts in behavior included buying more frozen food, avoiding internet shopping (because of shipping and other costs) and switching to discount grocery retailers.
Rethink Inventory Aging
Approaches to inventory aging are inconsistent in the retail industry. Some retailers, having bought a particular product 90 days ago, opt to put all instances of that SKU in a “90-day bucket.” They will hold to this approach even if a big new shipment of the item has just arrived. Other retailers will respond to the new shipment by reclassifying all instances of the SKU as “brand new.” Many appraisal firms follow retail clients’ leads and report aging based on these arbitrary methodologies. But aging inventory based on demand provides a more accurate and actionable picture.
Demand-based aging involves a three-step process:
- Review recent transactions involving the inventory in question
- Run analytics to gauge likely consumer demand moving forward
- Age the goods based on the picture emerging from the data
This demand-based aging provides a flexible approach that befits today’s fast-changing marketplace. If a particular SKU of seasonal lawn furniture happens to be breaking sales records and a new shipment has just arrived, putting that inventory in a bucket like “30-day, fresh receipts” could be perfectly appropriate. However, the picture is quite different if a review of the past 60 days of lawn furniture sales reveals a gradual slumping in demand. In this case, the rate of sale could merit a “180-day” designation, as it could be next year before that product sells again.
The last thing a retail decision-maker should do is realize that today’s “30-day” inventory will, in reality, take 180 days to sell. This is important for lenders as well. Hold the going out of business sale in May and that 30-day lawn furniture might fly off the shelves; run it at the end of August when the item is 90 or 120 days old, and the recovery will be lower.
The Fundamentals Still Apply
Today’s consumers may be suffering from whiplash, but the fundamentals of assessing NOLV and borrower health have not changed. If inventory is up and comp-store sales and gross margins are down — an increasingly plausible situation for many chains today — it’s a red flag.
In many retail deals, the borrowing base is right on the line. By doing a deep dive into the inventory side of the equation — online sales, merchandise categories and overall levels included — lenders can keep retail borrowers out of the danger zone.
This article appears in ABFJournal.
Michael McGrail oversees Tiger Group’s appraisal and disposition practices. The 23-year industry veteran has directly managed the analysis, bidding process and operations of many of the largest asset-disposition projects in the United States.