Consumer worries: Why the second half of the year could be rough for retailers

Between inflation, supply chain issues, and concerns about consumer spending, there has been a lot for retailers to contend with. RapidRatings Executive Chairman James Gellert and Unity Marketing President-Founder Pamela Danziger joined Yahoo Finance Live to discuss the state of the retail industry right now. Gellert says smaller, private retailers are being "much more squeezed" than their larger counterparts.

Danziger, meanwhile, says "the biggest question right now for retailers is consumer spending." Danziger points to a recent report from the National Retail Federation that warns consumer spending is slowing and that "we're really looking at, I think, a very potentially contracted environment for retailers coming up in the last half of the year."

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Video Transcript

- Number of the big box retailers will be releasing earnings giving investors a chance to see how the sector has fared. Now, it's no surprise that retailers have been given the amount of attention that it has with a myriad of challenges, including inflation, wage growth, and supply chains.

Now, data from Epiq Bankruptcy shows all is still not rosy. The number of commercial chapter 11 filings registered in July increased 71%. Overall, commercial filings increased 21% in the same period. And small business filings increased 61% to 153 in July. Now, that's up from 95 in July of 2022. The total number of bankruptcy filings topped 35,000, indicating the economic recovery is still uneven.

Let's bring in now RapidRatings Executive Chairman, James Gellert, as well as Unity Marketing Founder and President, Pamela Danziger, to discuss this more. Big welcome to you both here. So James, I want to start with you here because as we talk about the metrics that you use in your ratings here, who are you seeing as the big winners and losers so far?

JAMES GELLERT: So good to be with you and Pamela, you as well. You just put up some very sobering statistics, and I think it frames out the conversation really well. We have a significant increase in bankruptcies and defaults but we have moreover, a ton of pressure on a lot of industries, retail being one of them. We look at financial statements of public and private companies to evaluate the financial health and core health, which is a longer term measure of businesses.

And what we have found since the end of 2021 is that retail is our second most declining sector. It is of 28 sectors the lowest that we have rated at the moment at a 61 on our 100 point scale, which compares to all of our coverage for public companies of a 55. So it's slightly better, but it is down 6.7 points since the end of 21.

Really, the big issue here, two big issues. One, private companies in the sector. Smaller companies, mid-sized businesses and retail are being much more squeezed than their public counterparties, and the leveraged position of companies is going to be the big story over the next six months but really, the next probably 24.

- And Pam, as we look at the landscape as a whole, obviously, you have interest rates. Incredibly tough if you're trying to refinance as a business. What are some of the retailers, when you look at that landscape, what are they telling you are their biggest issues?

PAMELA DANZIGER: Well, I think one of the biggest question right now for retailers is consumer spending. And when NRF just came out and announced that consumer spending is slowing, that is something that everybody should take notice of because just a month ago, they were saying that they had revised data that showed that there was underlying strength in the economy that was going to roll forward.

But right now, they're seeing something in their signals and their signs that say spending is down, and that's going to put back-to-school shopping at risk. And back-to-school shopping is a bellwether of what's ahead for Christmas and holiday shopping. So we're really looking at a really, I think, a very potentially contracted environment for retailers coming up the last half of the year.

- And James, when you look at some of the rising debt levels for these retailers here, are there certain companies that are managing this debt better than others, especially when you look at this spike that we're seeing in bankruptcies?

JAMES GELLERT: Well, you've got the largest companies in the space, the Walmarts of the world, Target. Walmart rated at 68, Target rated at 63. These are strong ratings in the grand scheme of things. And they will continue to have access to the capital markets perhaps with slight variations on funding costs. But it's again, the smaller companies and to Pamela's point, the ones that are more susceptible and exposed to some of the vagaries of maybe consumer spending habits for non-discretionary or rather for discretionary items.

So you look at the companies like a Wayfair, for instance, with an FHR of 20 and overstock has dropped recently to a 41. These are companies that have been able to manage their debt reasonably well by kicking the can down the road and refinancing. But as their maturities begin to come due, they will certainly have more pressure on them.

And for contrast, Bed Bath & Beyond when it filed for bankruptcy was rated at 25. Tuesday morning at 25, Party City in 18. So companies in the 40 and below range are in the highest risk of failing historically, and those are the ones that we're seeing continue to flash a lot of red lights.

- And Pam, as you look at this issue of what we're seeing with a potential recession coming down the road, you also have student loan debt repayments about to kick in. So that's even less discretionary income as well. When you look at that outcome there, when you look at the bigger companies versus the value plays, what sort of environment should we be looking at timeline-wise?

PAMELA DANZIGER: Well, that's a question that nobody has an answer for, but I think we're seeing increasingly 2024 is going to be tough. And again, if the retailer-- if consumers pull back as I expect them to-- and we talk about credit. The consumer credit cards are maxed out now. They owe over $1 trillion in credit card debt, so that's taking a bigger chunk of their discretionary spending out.

So I think we're looking at an environment next year that whether or not we have a recession, I think we're going to be in a place of stagflation, like remember back from the 70s, with smaller retailers more at risk from declining consumer spending.

- And James, when you look at how much the consumer has changed, obviously, a lot of these companies are trying to get a handle on what the consumer wants. We saw the backlog when it came with inventory. What do you think is going to be the next catalyst for retailers as you give an outlook?

JAMES GELLERT: The story for the last couple of years has been supply chain. The story for the next couple of years will continue to be supply chain. Now, the companies that have the greatest access to supply ahead and are able to plan for consumer spending changes over the coming quarters are really the ones that are going to be best positioned. The ones that have less resilient supply chains, don't have as much insight into the goods that they're buying or have suffered disruptions of one kind or another, they're the ones that are going to have a trickier time managing consumer preferences.

Bed Bath & Beyond again is a great example of a company that really lost the confidence of its suppliers as it was facing a lot of its problems. And then of course, lost the confidence of its consumers as they would show up to stores and not see the goods on the shelves that they wanted.

But as you go upstream in supply chains, you have smaller and smaller and more often private companies that are highly exposed to the rising interest rate environments and floating rate debt because they tend to be more bank borrowers than they are long-term bond issuers. So in their cases, the cost of capital have increased on top of the costs of labor and the costs of goods. So they're the ones who are more impinged, and they can't necessarily pass those costs through to their ultimate customers or the larger retailers that they're selling to. Those are the ones that are really going to be at the most risk over the next 24 months.

- So Pam, until we see interest rates start to come down and consumers feel more comfortable here, is anything else really going to change this situation? What is a new normal going to look like after being so comfortable with historically low interest rates for so long and now these bankruptcies continuing to pile up?

PAMELA DANZIGER: Yeah, well, I think the word-- and I remember the '70s, I think the word is going to be kind of a stagflation. People are going to put off buying discretionary products and making discretionary purchases. I mean, already, LVMH, Kering, Richemont, Prada, and Burberry already saw reduced spending in the US on luxury goods. And luxury is the most discretionary of purchases, and it's the one that is most easily put off. So I see them-- I see luxury is also threatened and in a bad place right now from what's happening with consumers.

- And James, that's interesting because we know that for at least most of the post-pandemic, luxury spending was pretty resilient here. As you look at perhaps some of these luxury retailers versus the value plays, who do you see then as perhaps coming out on top? As we are starting to see some of those cracks in the luxury spending market.

JAMES GELLERT: Well so, I think the winners here are-- luxury has a place and will continue to have a reasonably well-supported customer group. But it will vary from quarter to quarter as Pamela has just rightly pointed out.

But a big issue I think we will see going forward is acquisition and event risk among these names. So we're already beginning to see some consolidation in the industry. I believe we will see more of that. And there's a whole world of private capital, both private equity and private credit that has a lot of dry powder and has been a bit on the sidelines more than at least over the last 10 years over this past year. And this past year, the dry powder just continues to build up.

So more private equity firms are going to get into the space and beginning to look to crank up some of the brands that may be strong brands historically but running into a little bit of a challenge from a financial perspective today. And we'll see a lot more of that coming up for the balance of this year and in '24.

- I do appreciate you both joining us this morning here. A big thank you there to RapidRatings Executive Chairman, James Gellert, as well as Unity Marketing Founder and President, Pamela Danziger. Thank you both.