Rite Aid’s bankruptcy last week was the latest toll of a rising wave of American companies that couldn’t afford to pay their debt any more.
Businesses are squeezed by inflation and falling consumer demand on the one hand, and record high interest rates and financing costs on the other. That’s never a good combination, especially for companies already short on cash.
Last summer, Barron’s flagged seven companies at risk of a liquidity squeeze—ones with weak cash balances and high short-term debt. Three names on the list—Party City (PRTY),
Bed Bath & Beyond
(BBBY), and
Rite Aid
(RAD) have filed for bankruptcy protection this year.
Bed Bath & Beyond has since relaunched as an online-only brand under new owner Overstock.com, while its stores are sold to pay back lenders. Last month, Party City exited bankruptcy with a reorganization plan to cancel $1 billion debt by converting it to equity shares owned by its lenders.
It might be a good time to take a look again and see which companies are on the updated watch list.
As inflation pushes many consumers to tighten their belts, companies are seeing softening earnings in 2023. That’s bad news for those with little free cash to pay for the coming debt. Over the past decade, companies could usually refinance their debt at ultralow rates and kick the can down the road.
That’s become challenging now. The Federal Reserve’s rate hikes since last year have pushed the benchmark rate to between 5.25% and 5.5%, the highest since 2001. That means riskier junk-rated issuers would have to pay even higher rates—as much as 10%—if they want to borrow more money. In some cases, additional credits might not be available at all.
As companies can no longer refinance their way out of difficulty, debt defaults and insolvencies have picked up. By midyear, the volume of soured debt in the leveraged loan market had already surpassed the first half of 2008 when the financial crisis was unfolding, ranking only behind 2009 and 2020, according to Goldman Sachs.
S&P Global expects the default rate to continue climbing next year as more debt matures through 2025. In the first three quarters of 2023, at least 516 U.S. firms have gone bankrupt, the highest tally since 2010 besides 2020. More companies could fall into trouble as the Federal Reserve is expected to keep rates higher for longer.
To spot companies facing a potential cash crunch, Barron’s looked for firms whose short-term obligations, including debt and rent payments, are more than their cash balance and one-year earnings combined as of the latest quarter.
Among those, we further zeroed in on firms whose cash reserves have shrunk by more than 20% from a year ago—a sign that things aren’t improving. A few names stood out:
WeWork
(WE),
Sportsman’s Warehouse
(SPWH),
Children’s Place
(PLCE),
Sleep Number
(SNBR), and
Funko
(FNKO).
In March 2023, WeWork reached a deal with investors to significantly reduce its debt and push out the deadline for its remaining debt until 2027, two years later than the original maturity terms. Still, by the end of the second quarter, the office rental company had nearly $900 million of lease liabilities due in a year, but only $234 million cash on its balance sheet, according to FactSet.
“Despite the important actions we’ve taken over time to improve our company and real estate footprint, our current lease liabilities—which were over two-thirds of total operating expenses in the second quarter—still remain too high and are dramatically out of step with current market conditions,” said CEO David Tolley in a public letter last month.
Tolley said the company’s focus in the next phase is to permanently fix its inflexible and high-cost lease portfolio. The firm has already started to engage with its global landlords to renegotiate nearly all its leases, said the CEO, and that might involve exiting some unfit and underperforming locations. The company hasn’t been profitable since it went public in 2021.
A few specialty retailers are also struggling with draining cash reserves amid dwindling earnings, as consumers cut back discretionary spending. Many can still draw liquidity from their revolving credit lines, but borrowing more money now would mean higher interest expenses down the line.
Take Sportsman’s Warehouse, which sells sports equipment and apparel. In the second quarter ended in July, sales fell by 12% from the year-ago period and the company posted a net loss of $3.3 million. That’s a contrast from the same quarter last year, when it made $14.6 million in net income.
By the end of the latest quarter, Sportsman’s Warehouse had more than $200 million outstanding debt and a $48 million lease payment due in a year, but only $3 million in cash. The company could draw an additional $96 million from its revolver and plans to reduce its inventories to free up more cash.
“We will move swiftly with the greater velocity of promotions and markdowns to lower our total inventory levels and drive more traffic to our stores,” said CFO Jeff White in the latest earnings call.
Likewise, bed and mattress chain Sleep Number had just $2 million cash by the end of June, but $484 million in short-term debt and $82 million in lease liabilities. Sales shrunk 16% in the latest quarter from a year ago, and net income fell from $35 million to less than $1 million.
The Children’s Place, a retailer specializing in kids apparels and accessories, had $19 million in cash by the end of July, but $348 million in short-term debt and $65 million in lease liabilities. Sales fell by 9% from a year ago, while the net loss nearly tripled to $35 million.
Sleep Number had $334 million of liquidity under its revolver as of the latest quarter, and the Children’s Place expanded its credit line from $350 million to $445 million in June. Thanks to the rising interest rates, both firms’ interest expenses have nearly tripled from a year ago.
Neither companies responded to Barron’s requests for comment.
Funko sells pop culture collectibles like vinyl figurines and bobbleheads. By the end of June, the company had $37 million cash but $163 million in short-term debt and $18 million in lease liability.
Sales dropped 24% from a year ago in the latest quarter ended in June, while earnings turned from a $15 million profit to a loss of $73 million, partially due to “ongoing inventory destocking” by some of the firm’s larger wholesale customers, said Michael Lunsford, Funko’s Interim CEO at the latest earnings call.
The company will focus more on its core products and operate “like a lean start-up,” he said. Earlier this year, Funko laid off employees and began cutting down inventories to save storage expenses. The plan, when completed, is expected to shave the firm’s annual costs by $155 million to $185 million, according to the company.
Write to Evie Liu at evie.liu@barrons.com
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