Is the Eddie Bauer Bankruptcy the Beginning of the Second Wave of Retail Bankruptcies?
Eddie Bauer filed for bankruptcy yesterday, and many commentaries linked the filing to other recent retail bankruptcies, such as Linens ‘n Things and Circuit City. Every bankruptcy is different, however, and in its filing the company cited an unworkable debt load it inherited in 2003 during its spinoff from Spiegel.
But this bankruptcy is different for another reason, coming as it does near the end of the spring selling season. It may represent the beginning of a possible second wave of retail bankruptcies, after the initial wave last fall and over the winter in response to the collapse of business then. We could be seeing additional bankruptcies over the coming months, of retailers who were able to weather the initial storm, but could not make it through the next season.
There are several possible reasons for this, but every one must begin with the condition of the Balance Sheet before the downturn got really bad. Weak companies could only grow weaker in this environment of dramatic sales decreases. But the possible immediate causes serve as a cautionary tale to the many small, independent specialty retailers struggling to hold on until business finally begins to improve.
Obviously, the backbreaker is that cash declines to unsustainable levels, triggered by the retail sales drops. But there are two other causes that flow from the sales decreases that can have a cascading effect on cash that retailers have to guard against. The first is the failure to reduce retail inventory levels immediately, in line with the sales decreases, and to keep them in line with prudent, conservative sales plans until business actually turns up. When sales drop, no retailer can sustain excessive levels of inventory indefinitely, waiting (hoping!) for the customer to return.
The second, and related cause, is the slow drip-drip of cash resulting from eroded retail margin percentages. These eroded margins could be the result of heavy markdowns necessary to right-size the inventory, or a policy of continual promotions intended to drive volume. One way or another, unless corrected, margins that are maintained at levels that fail to cover expenses will eventually run cash dry.
At this point, most retailers have taken the steps to get their inventories in line. The greater risk now, as sales are beginning to stabilize, is the slow, steady erosion in cash balances that result when margins remain below sustainable levels. This is the greatest danger now, and, if we do in fact see a second wave of retail bankruptcies, will very likely be the straw that broke each of the camel's back.