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Distressed retail debt will not be back in vogue soon

A few seats away from starlets Adriana Lima, Amber Valletta and Diane Kruger in the salon at New York’s St. Regis hotel, buyers from the department store chain Bergdorf Goodman were trend-spotting. They were there to see Jason Wu’s latest autumn collection, a line-up full of amber gold velvet draped dresses, smart glen plaid workwear and sheer slip dresses in lace and tulle.

It was easy to get lost in retail fantasy at the St. Regis but just blocks away are the skyscrapers that are home to bond investors for whom the retail sector has been anything but fantasy in 2017. The debt sold by lowly rated retailers eclipsed the energy sector as the most distressed in January as their bond prices have fallen steeply over the past year.

Bonds sold by Neiman Marcus, which owns Bergdorf Goodman, have tumbled to roughly 58 cents on the dollar from 80 cents in December after the indebted company pulled plans for an initial public offering.

The pain is not limited to Neiman, or the high-end department stores selling luxury goods. Debt from J Crew, the mid-American preppy retailer, trades at 44 cents on the dollar while the bonds of 99 Cents Only Stores trade at 66 cents.

Department store chain Sears is hoping to lop $1bn off its cost base, Ralph Lauren’s chief executive exited the company amid strategic disagreements with the founder, Warren Buffett’s Berkshire Hathaway slashed its stake in Walmart, and Macy’s is closing underperforming stores and considering a tie-up with Canada’s Hudson’s Bay, the owner of Saks Fifth Avenue.

There are good reasons to be sceptical that this debt and equity will come back into vogue anytime soon.

The US retail industry is reckoning with secular decline, triggered by changes in consumer shopping patterns, overly commoditised offerings and the fallout from a leveraged buyout boom that saddled some of the country’s most venerated brands with unsustainable levels of debt. And that is all before the Amazon effect is considered.

Institutional fund managers say they are waiting patiently on the sidelines for opportunities as the sector’s most indebted companies restructure. Retail investors are following the lead of professional money managers. More than $8bn has flown out of the asset class since 2016, according to EPFR.

They are smart to do so. Junk retail is the only part of the high-yield market to suffer losses this year, data from Bloomberg Barclays Indices show. The cost to investors of buying protection against default has soared while investors have already been rankled by a move by J Crew, which shifted some of its intellectual property to an international subsidiary.

Covenant Review, a firm that analyses indentures and credit agreements, says there are nine other retailers who could make the same move that puts assets beyond lenders’ reach in the event of a default.

There are likely to be more defaults as sales growth proves elusive and margins are squeezed. Peter Stournaras, an equity portfolio manager with BlackRock, says he sees no good reason to shift from his underweight position on retail.

David Daigle, a corporate bond portfolio manager with Capital Group, adds that restructuring advisers have been putting “a lot of time” analysing the retail industry.

“The fact they’re spending their man hours looking at the industry and who may be unable to service their debt is one indication of the stress in [retail].”

The Dow Jones US apparel retailers index has fallen 9 per cent from a December peak. The broad market S&P 500 has gained 5 per cent so far this year, touching another intraday high on Thursday.

Discipline from investors is now critical. That is made much tougher given the $11bn that has poured into high-yield bond funds since the US election, adding to the already high cash balances money managers are running.

Yet distressed retail bonds are cheap for a reason and will remain so until managements can plot a convincing path to sales and profit growth.

At the St. Regis, Mr Wu took his bow in a black zip hoodie and white sneakers, a nod to the rise of athleisure — workout clothes you can wear to brunch. It is a trend that is not playing into the cards of most of retailers, including Neiman, J Crew, Ralph Lauren or Sears. It is something junk bond investors know all to well.

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Twitter: @ericgplatt

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