Bankruptcies will continue to rock retail in 2018. Here’s what you need to watch

Charming Charlie store

Source: Charming Charlie

As 2017 comes to a close, the retail industry has been tainted by yet another bankruptcy filing — and 2018 is unlikely to bring relief.

Texas-based fashion accessories chain Charming Charlie filed Monday for Chapter 11 bankruptcy protection, having recently announced it would be moving forward with slimming down its store base.

Now, the retailer has secured millions of dollars in loans, which once approved by the court will aid Charming Charlie in keeping the majority of its locations open and its website operating during bankruptcy proceedings this holiday season.

The hope is Charming Charlie will emerge from the restructuring with a smaller store footprint and a strategy that goes “back to basics,” the company explained.

Charming Charlie marks one of many names struggling to grow sales as consumers increasingly turn to the internet and popular off-price chains to ring up purchases. Chief Executive Officer Lana Krauter said in a statement Monday the company has been plagued by a “rapidly changing retail environment.”

This year alone, more than 20 retailers including Toys R Us, Hhgregg, Gymboree and RadioShack have filed for bankruptcy protection. Looking to 2018, there are many candidates that could follow in the footsteps of their embattled predecessors.

Moody’s has been tracking a growing number of distressed apparel and specialty retailers in 2017, anticipating more bankruptcy filings to come next year.

“I think the early part of next year will be pretty bad … I think it will be tough,” Moody’s lead retail analyst Charlie O’Shea told CNBC. “Think about it: if you’re a highly leveraged brick-and-mortar retailer, how do you compete” with Walmart and Amazon‘s outright price war, he added.

Among Moody’s rated retail and apparel issuers with debt ratings of ‘Caa’ or lower (which represents anywhere from “substantial risk” to the potential for total default on a bond) are kid’s accessories chain Claire’s Stores, apparel retailers J Crew and Charlotte Russe, department store chain Bon-Ton Stores and grocer Bi-Lo.

A considerable threat to many retailers’ (such as Charming Charlie and Claire’s) businesses today is not owning a product or service that consumers couldn’t find elsewhere. For example, U.S. mall anchor Sears Holdings, which also ranks poorly on Moody’s list, has lost sales as shoppers opt to pick up appliances, furniture and other hard goods from alternative outlets.

Moody’s analyst Christina Boni told CNBC she’s keeping close watch on a slew of Sears’ maturities in fiscal 2018. Meantime, the retailer’s asset base is declining as its turnaround efforts appear “elusive,” she wrote in a recent note to clients.

Taking into consideration the threat of foot traffic dwindling at many of America’s malls, risks begin to mushroom for brands such as J Crew, Nine West, Charlotte Russe and Vince.

Christopher Jarvinen, a partner at Berger Singerman in Florida, told CNBC he advises watching real estate investment trusts and mall owners Simon Property GroupGeneral Growth Partners, and Macerich, to see how they respond to the noise.

“The mall model is dead,” and the future is more temporary tenants and mixed-use developments, he said. Jarvinen, who has represented numerous retailers including Traffic Shoes and Simply Fashion Stores through Chapter 11 bankruptcies, said REITs could also help more retailers come out of filings next year in a stronger position, to avoid having a “dark” store.

Simon and GGP, for example, won an auction to purchase teen apparel retailer Aeropostale after it filed for Chapter 11 bankruptcy protection last year, hoping to avoid having to fill more than 200 vacant stores. The two companies have since managed to salvage the Aeropostale nameplate.

Moody’s so-called watch list has ballooned to 27 names from 22 companies this summer, as a load of retail debt is coming due in 2018. A recent addition to the list was General Nutrition Centers, or GNC, which is also a popular U.S. mall tenant. One of GNC’s rivals in the space, Vitamin World, just filed for bankruptcy in September, saying the company hopes to get out of costly lease agreements tied to some of its locations.

“Next year I think you’re going to see smaller-format stores, people reassessing their mall strategies, especially as anchors struggle in a lot of malls,” O’Shea said. “The retailers that are winning … are in the best financial position and have the best flexibility” with their locations and sales channels.

Fitch Ratings, which keeps track of companies with glaring “loans of concern,” is calling for a higher retail default rate in 2018 — above 10 percent — as more defaults involve sponsored transactions, or private-equity related activity.

“Two or three years back … we saw private-equity funds get into the retail sector and over-leverage the retailers they were buying,” Jarvinen told CNBC. “Now, we see the cash flows not being able to service that debt.”

One thing to look for in 2018 is more retailers actually firing back at PE firms for “fraudulent transfers” that hurt their businesses in the long run, Jarvinen added. Additionally, more and more family-owned retailers, of which there are plenty across the U.S., are being pushed into filing for bankruptcy at the last minute due to lack of resources and ability to plan, he said.

Fitch has also noticed retailers recently emerging from bankruptcy at lower market values compared with historical averages.

In general, retail stocks have struggled. Over the past 12 months, the S&P 500 Retail ETF (XRT) is down more than 6 percent, even with recent gains driven by expectations for strong holiday retail sales.

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