Thursday, November 15, 2018

Overconfidence Stings JCPenney, Department Stores

When a close competitor fails, it is good news and bad news. The good news is that you might be able to pick up some of the customers. The bad news is that you too might fail from the same market forces.

Department stores that see the expected liquidation of Sears and Kmart as good news are missing the bigger picture. It is not just that department stores collectively will lose customer visits to Sears and Kmart during store closing sales. The whole department store concept is in decline. The mall concept is in decline. The question at this point is not how to stem the decline, but how to best manage it.

Target, JCPenney, and Macy’s have been the most overconfident in reacting to the decline at Sears and Kmart. The folly in this view was brought home with the new report from JCPenney, which saw a staggering decline in sales in the third quarter, down 5.4 percent. Inventory overhang continues to be a major concern — also down 5.4 percent, but that means inventory remains just as bloated as before when seen in proportion to revenue. A few quarters had looked promising at JCPenney with actual gains, however minimal, in same-store sales. This plateau may, in retrospect, be seen as an accidental result of the whims of popular culture in an otherwise directionless company. The stock hit an all-time low after the report and faces the risk of being delisted if things do not turn around in the next few months.

When comparing JCPenney to Sears, it is important to note that JCPenney is doing worse than Sears by most measures. Most importantly, the Sears brand still stands for something. JCPenney has changed direction so many times in the last quarter century, it no longer has a brand identity. The only reason JCPenney looks better at this point is that Sears went into bankruptcy.

If Sears and Kmart are suffering from inventories that are too thin, department stores in general will suffer from the overblown inventories of the overly optimistic stores. Those items will have to be discounted as soon as December arrives, putting pressure on every department store. The price pressure will be that much more intense if all Sears and Kmart stores are in liquidation by then.

Wednesday, November 14, 2018

Democracy vs. Olympics: Calgary Votes No

Another Olympic hosting effort has come to an end as it became clear that local citizens were opposed. CBC News reports 'The people have spoken': Calgary mayor confirms 2026 Olympic dream is dead after vote. Calgary residents voted on the question of whether the city should proceed with its attempt to host the Olympics. It was a decisive vote, with 56 percent of voters opposed.

The troubling thing about the Calgary bid to host the Olympics is how far the process went in spite of never attaining any meaningful legislative approvals and never having a significant level of local support. It seems as soon as a committee was assigned to study the possibility of the city hosting the Olympics, that process took on a life of its own, with no one able to put the brakes on when that was needed.

It was not the voters so much as a budget shortfall of several billion dollars that killed the Calgary Olympics. There is no doubt that the funding shortage, and the scenario of the city residents paying it off over the next forty years, helped persuade some voters to turn out and vote no. Had the Olympics hosting budget balanced, the plan might have gone ahead in spite of local opposition. Conversely, even if voters had voted yes, the hosting proposal could still have fallen apart because of a lack of funding.

What this saga suggests is that there is a fundamental conflict between the Olympics and democracy. Realistically, a city probably cannot host the Olympics or an international sporting event of similar scale unless it is done without letting the people have a voice in the process. When you look at the ethical implications of city taxpayers backstopping the finances for what is, in financial terms, a U.S. television show, that is reason enough for principled voters anywhere to vote no, assuming they are asked.

If the Calgary Olympics story gives you a sense of déjà vu, that may be because it so accurately duplicates the recent story in Boston. There, the budget shortfall was similar in scale, and it was the tireless efforts of community organizers focusing public opposition that brought that project to a stop. But as in Calgary, it was a planning effort that took place behind closed doors with no public support and very limited governmental approval. The thought in Boston was that a major event that would permanently scar the landscape of the city could be shoved down the public’s throat. It is a way of thinking so far removed from democracy that it is no wonder it ran into trouble.

The Olympics may be able to carry on a little longer by holding events in places that are more authoritarian, but eventually, the clash between Olympics and the public interest has to become an embarrassment, not just to the Olympics, but also to its supporters and sponsors. The long-term decline in the U.S. TV sports audience will undercut the prospects for the Olympics ever becoming self-funding. If the Olympics must be a money-losing operation, it really should be financed properly, by charitable donations, rather than by bait-and-switch and hot-potato tactics to cobble together public funding. The two-year cycle of searching for a city where people are gullible enough to agree to host is hardly a reputable way to run such an enterprise.

Friday, November 9, 2018

Muted Christmas-Season Hiring

Christmas-season hiring has been quiet in the United States, and no one is quite sure why. An obvious structural change is that Amazon is hoping to lean heavily on its own delivery network for the first time this quarter, giving UPS and FedEx Home Delivery little reason to project enormous growth over last year. A possible Sears and Kmart liquidation, the earlier Toys ‘R’ Us liquidation, a pattern of early-December layoffs of seasonal personnel in 2017, and a tight labor market are reasons for retailers to hold back on hiring this time around.

Walmart, the largest employer in the United States by some measures, says it will not be hiring any seasonal workers. Instead, its regular employees will be preparing for long hours of overtime during Thanksgiving week and the two weeks before Christmas. Walmart will pay a fortune in overtime, but that could still be less than the fortune it would spend on the hiring process. Amazon’s seasonal hiring is smaller than last year despite estimates of 9 percent revenue growth compared to last year and a new need for tens of thousands of delivery drivers. Improved automation may be the explanation for a smaller seasonal army in Amazon’s warehouses this year. Fear of unions is another reason why Amazon is trying not to employ such a large number of workers doing the same work at the same location. Target is trying to hire a large number of seasonal store employees, but not quite so many as last year. Macy’s, stung by low December traffic after hiring an extraordinary number of seasonal workers in 2017, will not be repeating that mistake this year. JCPenney and Best Buy are the two largest retailers I could find that intend to hire more workers than a year ago, but they are hiring only now, so seasonal workers should expect to work only 100–200 hours in total.

If I had to sum up the seasonal hiring, I would have to say that uncertainty is making companies hesitate. Consumer confidence might be strong, but it does not feel solid. Retail patterns are shifting, with more online shopping than ever before, but consumers also starting to get tired of online shopping. More retail bankruptcies and liquidations are expected, and the impact on any given retailer is hard to predict. With a renegade White House and a divided Congress, there is a palpable risk of a constitutional crisis. To business planners, it looks like a good time to be cautious in plans.

Wednesday, November 7, 2018

Problems in Bankruptcy for Sears

Sears’ bankruptcy filing came with an unusual clause describing financing to be arranged later. I originally thought that the bankruptcy financing would have to be worked out by the beginning of November for the retail giant to avoid Christmas-season liquidation, but that date has passed and there is no sign of the money needed to keep Sears and Kmart stores operating through the end of the year. Last weekend there were whispers of a deal to rescue the Sears retail chain, but apparently financing remained an obstacle and that deal did not come through. Without the planned financing, Sears shelves could be half bare by the time Christmas is here, and mall owners might start proceedings to evict the retailer after rent goes unpaid. Already things are looking desperate on the shelves at Kmart stores according to multiple published reports and video posted online.

There is a second problem. Creditors have asked for a formal review of insider deals at Sears over the last few years. There have been many insider deals between Sears and other companies controlled by its majority owner, deals worth billions of dollars, and some of the deals could end up being reviewed in bankruptcy court. In the worst case, if an investigation reveals an active coverup surrounding the transactions, that could lead to criminal charges against officers at Sears and its counterparties. As unlikely as that scenario might sound, merely raising the possibility of wrongdoing by officers makes it harder than it was already for Sears to arrange financing of any kind or make the kind of large-scale deal that could rescue the company from bankruptcy. Even a delay of a few weeks while the court considers these questions could ruin a deal.

In a practical sense, it is probably already too late to close the remaining Sears and Kmart stores before Christmas. The Christmas shopping season is already well underway, and it reaches its high point in barely three weeks on Black Friday. But a move to put the remaining stores into liquidation after Black Friday, while there are still some Christmas shoppers to sell to, does not seem particularly unlikely. Much depends on the cash flow at Sears stores. In theory, if traffic and sales were strong enough, the company would not need any further financing. But if shoppers stay away, worrying that Sears is not functioning normally or mistakenly believing stores have already closed, Sears will run out of cash before Black Friday, and then there will be no legal mechanism available to stop an early liquidation. Unfortunately, the latter scenario is more likely than the former.

I still believe that removing Sears’ executives provides the only plausible hope of having the company make its way through bankruptcy. Creditors, lenders, and investors have no reason to place any faith in the current management team, the same people who ran two legendary retail names into the ground. The sooner current management can be removed, the better the chances of salvaging something of Sears and Kmart. But so far, there aren’t any moves in that direction.

Update, Friday, November 9: Sears has announced 40 more store closings. The new list is concentrated on the East Coast and includes 29 Sears stores and just 11 Kmart stores. At a glance, it seems fair to guess that these stores are low-performing stores that were mistakenly left off the original list. It could be that the company thought it could find a buyer for some of these stores in bankruptcy because of their favorable locations.

The original store closing list is now said to be closing “in 2018,” which I think in practice means the two weeks after Christmas. Stores on the new list are expected to close “February 2019,” which will surely be January in a few cases. No one should be surprised if 100 more stores are added to this new list. At this point, closing all stores in February would not be a big surprise.

The new store closings do little to close the funding gap. Sears still needs a loan of well over $100 million just to keep the doors open through Christmas, and it is hard to imagine any large bank putting that amount of money at risk just so a failed retailer can keep doing what it was doing already. The only scenario I can imagine is a consortium of five or more banks and hedge funds, but lenders would require a substantial change in management, probably larger than Sears can stomach. Bankruptcy financing deals are not very complicated — the loan contract can be as simple as a two-page memorandum — so if such a compromise were possible and made business sense, the company should have arrived at it by now.

Update, Tuesday, November 13: CNN reports a filing by creditors to put Sears into liquidation. Creditors can hope to get about 4 percent of what they are owed if Sears is liquidated, but fear there will be nothing left if stores stay open for a few more months. The motion apparently originated with mall owners and represents the view of only a small fraction of Sears’ creditors, but it has an immediate legal impact nonetheless. Sears now has to persuade the court that the bankrupt company’s plan works out better for creditors. In that connection, the liquidation filing puts more pressure on Sears to show that it has the financing it needs to stay open through the end of the year. A ruling on the motion to liquidate could happen this week, or the court could decide to wait for Cyber Monday so it can consider the impact of Black Friday revenue.

Update, Thursday, November 15: Bankruptcy court, in a hearing today, has put off a decision on liquidating Sears for one month. Yesterday, Sears obtained a $350 million line of credit which, even if sales are disappointing, should allow it to stay open into January. Realistically, Sears needs to show a reasonably strong holiday season to avoid a liquidation order in December.

Tuesday, October 23, 2018

Hasbro Report Confirms Setback in Toy Sector

Hasbro’s earnings report confirmed what industry analysts had been saying all along: toy manufacturers will lose sales because of the closing of Toys ‘R’ Us. The two largest U.S. toy manufacturers, Mattel and Hasbro, were disproportionately represented on the shelves at Toys ‘R’ Us, so they were expected to see a bigger immediate impact and to lose some sales permanently to other toy manufacturers with the loss of shelf space. There is nothing to indicate that the toy manufacturers are in any financial peril, however. They will be able to scale back production plans and carry on on a slightly smaller scale.

During the earnings call, Hasbro said there should be no long-term impact from Toys ‘R’ Us, but there is nothing to back up that assertion, while reports of layoffs imply that the company expects a permanent loss of a small fraction of sales.