A Diverging Retail Sector: A Comparison of Corporate Bonds

Retailers deemed non-essential were forced to shut down their physical brick and mortar locations during the coronavirus lockdowns, leading to much disruption within the industry; household names such as J.C. Penney, Nordstrom, Nieman Marcus, Kohl’s Stores and many others have been losing revenue rapidly. In recent weeks both Nieman Marcus and J.C. Penney have filed for bankruptcy protection, along with other well-known retailers such as Pier 1 Imports and J Crew.
On the other hand, retailers such as Walmart and Costco have not only been able to stay open during the lockdowns but have thrived. The shares of both companies are up over 5% year-to-date through the end of May, in contrast with the S&P 500 index which was down almost 6% for the year. Additionally, both companies have a robust online presence as well. The importance of an online presence for a retailer is perhaps best illustrated by the stock of Amazon, which was up over 32% YTD through the end of May. This is likely a function of both their online presence and the fact that they sell a high number of products considered to be necessities, including at their Whole Foods subsidiary.
The current state of retail has not only been reflected in the performance of publicly-traded retailers in the stock market, but also in the bond market. This includes debt that has been downgraded as well as new issuance during this period.

Increased retail downgrades reflect ongoing financial headwinds

Out of the 43 names in the sector with corporate debt, 18 have been downgraded by S&P during the months of March and April of 2020. Of these downgrades, 13 were for bonds that already were graded as junk. These issuers were already on shaky financial footing, so the impact of the lockdowns, as well as the financial pain that many consumers are feeling due to the financial impact of the pandemic, have certainly not helped the retailers’ situations.
Despite the increased downgrades and bankruptcies, the total return on the retail bond sector was 0.93% for the current month to date and 11.47% over the 12 months. The overall spread on the bonds in this sector is just over 200 basis points. However, if we carve out the high yield portion of the sector only, we see spreads in excess of 900 basis points and a total return of -8.89% over the past 12 months.
In the high yield sector, there are no issues currently trading at a premium to their par value. On the other hand, there are any number of issues trading at incredibly deep discounts. Of note here are several JC Penney bonds trading at just pennies on the dollar.
Among investment grade bonds there are a number offering attractive yields to maturity and that are selling at a discount to their par value. There are also a number of high-quality retailers whose bonds are trading at a premium and offering solid total returns, such as Amazon, Target and The Home Depot. This indicates the divide in the retail sector overall.

New investment grade bond issues highlight division in the sector

While the retail sector as a whole has struggled, there have still been 15 new bond issues within the retail sector, all but one of which have been investment grade. These new issues account for about $15.8 billion in outstanding debt. The average debt rating on these new issues was BBB+ and the average duration is 8.24 years.
The average current yield on these new issues is 3.78%, with an average yield-to-maturity of 2.94% and an average yield-to-worst of 2.96%. The spread on these new issues is around 200 basis points. This compares to current statistics on the average high yield bond within the retail space which has a current yield of 7.55%, an average yield-to-maturity and average yield-to-worst of almost 10%. The spread on high yield bonds averages almost 903 basis points. A comparison of the statistics illustrates the perceived risk that bond investors have concerning the business prospects of the issuers of these bonds.

A deep dive into 4 high yield retail bonds

An analysis of four retail bonds with a duration in the 7-8 year range illustrates the dichotomy that exists among retail brands, even among issuers whose bonds fall into the high yield category. While these bonds are all high yield, there are some noticeable differences, including that:

• Brands that are primarily brick and mortar have been hit the hardest: The Macy’s and Bed Bath & Beyond issues both have total returns on a year-to-date basis around -40%. These are bonds with coupon rates ranging from 5.165% to 6.7%. Both of these issuers are old line, primarily brick and mortar retailers who have been hit hard by COVID-19 related lockdowns. Macy’s in particular was already having financial issues even prior to these lockdowns.
• Brands with strong online presence struggled, but less so: While certainly nothing to write home about, the Qurate bonds posted a total return of about -14% YTD and the L Brands bonds were at about -15% YTD. Both companies have robust online businesses and it would appear that the online and technology-based nature of these firms has aided bond holders a bit compared to the other two issuers whose business models are based on traditional bricks and mortar retailing.
• Already shifting consumer behavior could change retail quicker: While the division in retail may be short-term in nature due to issues surrounding the COVID-19 pandemic, but it also may be emblematic of the changing face of the sector. Prior to coronavirus, retailers without a strong online focus were already struggling; this lockdown may have put the sector over the edge though. Bond investors need to be attuned to these changing trends.

The retail sector is full of haves and have nots. This is true when it comes to both companies’ equity shares and their debt issues as well. Old line, traditional bricks and mortar retailers are often the ones having financial troubles and this is reflected in the pricing and the ratings of their bonds. Many innovative retailers with a solid online presence, or whose business is key to the everyday lives of consumers, are experiencing the opposite. Regardless of the company, it is clear that coronavirus shook up the industry.
*Bond prices and yields are all as of June 9, 2020 from IMTC NOVA.
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