As the coronavirus has broken loose and decimated the financial position of companies across sectors, investment experts of all kinds have reiterated one common message: buy companies with solid balance sheets that can weather the storm.
And a note out from retail analyst at Morgan Stanley points out several brick-and-mortar focused retail companies that are highly leveraged and therefore particularly threatened by the no-revenue picture the virus presents.
Atop Morgan Stanley’s list of increasingly distressed retailers are Macy’s (M) - Get Report, PVH (PVH) - Get Report and L Brands (L BRANDS) , the first and the third of which had already been undergoing strenuous competitive pressures in their respective sub-businesses.
“We anticipate a meaningful, albeit short-term (1Q - 3Q 2020), impact to sales, profit and cash flow among our coverage universe among out coverage universe as a result of the Coronavirus outbreak,” wrote Senior Analyst Kimberly Greenberger in a note.
That may be optimistic. Many economists and macro strategists suggest that the virus could last a longer time and that the economic fallout from the virus once it’s over could be rough. Consumers, in fear, may not resume shopping fully. Not all job losses will be recouped. Retail stores will reopen slowly.
Meanwhile, some of these retailers have maturing debt payments due soon, making a near-term blow to profits potentially devastating.
Plus, “access to refinancing markets appears significantly constrained in the short-term,” Greenberger said. “Companies in our coverage with upcoming debt maturities in the next 12-24 months may encounter challenging market conditions.”
The Fed has indirectly injected cash into high grade corporate debt markets, raising bond prices and lowering interest rates, but higher risk companies with junkier debt haven’t enjoyed the effect.
Here is a look at these three troubled companies:
First off, Macy’s has a net debt that is 5.4 times its expected 2020 EBITDAR.
So its debt minus cash is 5.4 times what analysts largely expect the company to produce in earnings before interest, tax, non-cash expenses and restructuring costs.
A healthy ratio across sectors is usually around 2 to 3 times. Burlington (BURL) - Get Report, a generally thriving retailer (excluding the external shock of the virus) has net debt of 1.6 times its projected next year’s EBITDA. Importantly, those profit estimates may come down on account of the virus. Also, Lululemon (LULU) - Get Report might be a better comparison to these slightly higher end retailers than discounter Burlington is, but Lulu is net cash positive, making it hard to compare.
Macy’s saw its free cash flow shrink by about 50% to $600 million in 2019 and current forward estimates are for a potentially optimistic $480 million, according to FactSet estimates. Its debt has been downgraded to junk, although it has bought back some of it. That means it has parted with some cash but cancelled all future payments of the notes its bonds back.
The company has no debt due in 2020 but does owe a significant chunk of principal in 2021 through 2024, totaling to over $2 billion.
“We believe Coronavirus headwinds, as well as uncertainty around its restructuring plan, could contain liquidity and stress its ability to pay off upcoming maturities,” Greenberger said.
Macy’s pays a dividend that yields 26% at its current stock price and Morgan Stanley believes it will likely cut its dividend payment, as projected free cash flow can barely cover the payment.
Some believe Macy’s’ restructuring plan can work, as it will focus on e-commerce, a secular trend that has caused the company’s downturn of late. But a good digital strategy is now difficult to create.
L Brands’ net debt to EBITDAR is 5.5 times.
L Brands has $785 million in maturities coming in the next two years, in which time free cash flow is expected to total $612 million. The virus -- lasting indefinitely -- also poses more downside.
Morgan Stanley estimates the company needs just over $600 million in cash for working capital each year, leaving not much left for other items. The company has total cash of just over $1 billion and could call on a revolving line of credit of $1 billion.
L Brands recently sold much of its Victoria’s Secret business to a private equity firm. Positively, an increased focus on its strong Bed, Bath and Body Works business could be beneficial to growth.
Morgan Stanley expects a dividend cut. The yield is 9.7%.
PVH’s net debt to EBITDAR is 5.3 times.
The company has $100 million of maturing debt in the next 2 years, although that’s compared to more than $2 billion in expected EBITDA and more than $1 billion in free cash flow cumulatively in the next two years.
After working capital needs annually, the company, Greenberger estimates, will have $250 million in left over cash to cover debt.
The company may have to cuts its dividend or its share buyback program.
For Macy’s and L Brands, some may have seen these as buyout candidates or simply cheap buys before a business model turnaround. But the coronavirus adds a new dimension, making these names even more risky.
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