With the holiday season upon us, high-yield retailers face a test of how heavier debt loads can weather chillier consumer sentiment.
In October, retailers have placed six high-yield bond deals totaling $3 billion, the highest deal count in the sector for any single month since April 2011, and the second-largest amount by volume, according to data from LCD, a division of S&P Capital IQ. The highest monthly volume was in August 2007, at $3.8 billion. So far this year, there have been 23 deals totaling $10.1 billion, or 3.7% of total high-yield volume, on the back of even higher issuance last year, at 30 deals totaling $14.05 billion, or 4.1% of total issuance, according to LCD.
What’s more, issuers in the retail sector have not shied away from the market’s limits of leverage levels, or issuer-friendly structures. On one recent high-profile retail deal for Neiman Marcus, total leverage will run 6.9x, or 7.1x on a lease-adjusted basis. That company also revisited the PIK-toggle bond, and used the contentious structure as part of financing at the operating-company level backing the company’s buyout by Ares Management and Canada Pension Plan Investment Board, the first time a company has done so since the credit crisis.
In the year to date, the amount of bond deals in the retail sector used for dividends or stock repurchases totaled 21.4%, versus 7.4% for bond deals across all other sectors, according to LCD. J. Crew was one, issuing $500 million of six-year (non-call one) notes at par on Oct. 28, to pay a dividend to sponsors TPG Capital and Leonard Green & Partners.
Retail deals have also appeared in Europe. Douglas, owned by Advent, is in talks to buy French perfume retailer Nocibe from Charterhouse in a deal that will create France’s largest chain of perfumeries by number of shops. Perfume is one of Douglas’ five retail divisions, alongside Thalia bookshops, Christ jewellery stores, AppelrathCupper fashion, and Hussel confectioneries.
Retail transaction are underway in the middle market. CIT Capital [entity display=”Markets” type=”section” active=”true” key=”/markets” natural_id=”channel_2section_62″]Markets[/entity] and Garrison Investment Group provided $110 million in debt financing to Los Angeles-based Joe’s Jeans to back the $97.6 million acquisition of Hudson Clothing. The financing includes a $60 million, five-year term loan and an up to $50 million, five-year borrowing-based revolver.
Not all recent deals included [entity display=”bonds” type=”section” active=”false” key=”/bonds” natural_id=”channel_2section_8″]bonds[/entity]. Hudson’s Bay Company placed a $300 million second-lien, eight-year term loan at L+725, with a 1% LIBOR floor, to support the Toronto-based retailer’s $2.9 billion acquisition of Saks Incorporated. Financing also includes a $2 billion first-lien term loan, a $950 million asset-based revolver, and $1 billion of equity.
Leverage for Christmas
Historically, the high-yield retail sector has been riskier than the broader high-yield market. The average quarterly return is 2.07% for the retailing industry, and 1.92% for the BofA Merrill Lynch High Yield Master II Index, including data since 1997. However, risk is meaningfully higher, measured by standard deviation of returns: at 6.5% for retailing, versus 5.3% for the High Yield Master II Index.
Still, retail names have attracted private equity buyers.
“It’s a good period to see companies go private. They’re still producing strong free cash flow and have under-levered balance sheets. A period of choppy sales trends – that equity markets don’t like – may make them attractive targets for private equity firms,” said Liz Dunn, retail sector analyst at Macquarie.
“For the most part, healthy retailers can manage those debt loads unless they are a long-term loser of market share or have other flaws with their business model,” Dunn said.
At the same time, some iconic retail names are struggling. Rumors of a bankruptcy have pressured bonds backing J.C. Penney to lows. Bonds backing Sears Holdings, which last month issued a $1 billion term loan to repay revolver debt, have moved lower on negative sales trends.
The outlook for the key Christmas season isn’t bright. This week, Standard & Poor’s announced that U.S. retail and restaurant ratings outlooks will be stable with a slight negative bias as consumers keep spending in check during the holiday season.
“Standard & Poor’s Ratings Services’ base-case outlook for the remainder of 2013 reflects our expectation that many U.S. retail and restaurant subsectors will face weak demand in the critical fourth-quarter shopping season of 2013 and consumers will direct their spending with some care,” Standard & Poor’s analyst Robert Schulz said in an Oct. 22 economic and ratings outlook.
“Elevated gas prices, unemployment, and rising interest rates are some of the reasons, even before taking the government shutdown and federal budget inertia into account, which may cause households to further delay spending.”
Even stronger retailers are feeling a pinch. Specialty-apparel retailer Gap, whose corporate credit rating was upgraded to BBB- in May due to improved operating performance, announced flat sales for September and described the business environment as “challenging.”
“The retail backdrop is tough right now, but an average retailer performing in line with its peers should be able to manage,” said Dunn at Macquarie.
Of course, not all retail companies are subject to the same trends. Specialty retailers and those relying on mall-based traffic are probably worse off those catering to higher-end shoppers.
Retail bonds in vogue
So far, scarcity in the high-yield secondary market for significant amounts of paper, and slim pickings in the primary market after a slowing of new issuance since record levels of September, has largely buoyed recent high-yield retail bonds. Downward pressure on high-yield retail bonds has been confined to credit-specific news.
For example, bonds and loans backing retail chain Sears Holdings edged lower after the company posted declining sales and negative EBITDA for the third quarter and unveiled plans to explore a spin-off to shareholders of its Lands’ End and Sears Auto Center businesses.
Sears 6.625% notes due 2018 traded down one point, to 93.25, in low volume after the Oct. 29 news. Sears placed $1 billion of secured bullet notes, 6.625% notes due 2018, at par in September 2010. In the loan market, the Sears term loan due 2018 (L+450, 1% LIBOR floor) was bid at 100.25, off a quarter of a point from before the news, sources said. The company’s $1 billion term loan was issued a month ago at 99.
J.C. Penney bonds slid last week, in part on bankruptcy rumors. The company’s 5.65% notes due 2020 fell to 65.5 last week, and 6.375% bonds due 2036 declined to 61, record lows. J.C. Penney term debt due 2018 (L+500, 1% LIBOR floor), a $2.25 billion covenant-lite loan issued at 99.5 in May, edged down to 96.125/96.625.
“Sears needs to be run by a merchandiser, not a hedge fund investor. What I see happening is a slow liquidation of the company,” said Evan Mann, Gimme Credit analyst. “J.C. Penney has its own set of self-inflicted issues. Both are in different situations, facing a retail environment that’s getting a little sluggish.”
“For retailers that are struggling, you need a Christmas that’s a little better than in the previous year.”
Even a strong holiday season may not be enough to salvage specialty-clothing retailer Rue 21. Sector trends weakened from May when Apax unveiled a $1.1 billion buyout of Rue 21, saying it would buy the company for $42 per share. Standard & Poor’s rated the company’s $250 million of senior notes at CCC, and forecast leverage at the mid-8x area for the retailer, which focuses on middle-market communities.
Bookrunners Bank of America, J.P. Morgan, and Goldman Sachs were forced to off-load Rue 21’s entire $250 million of 9% notes due 2021 at 73, yielding 14.9% (T+1,272) last week, according to sources. Bonds have since been offered for sale in the high 60s, sources said. –Abby Latour