Chapter 11 Filing May be Warning Sign for "Treasure Hunt" Retailers

In its December 11 issue, Barron's noted the following (firewall): "Even the companies that look immune to the impact of the internet could be at risk. Consider off-price retailers like TJX ($TJX) and Ross Stores ($ROST). Bulls have argued that the experience of digging through the racks looking for buried treasure is something that can't be replicated online -- and that, they argue, puts them at an advantage to other retailers."Acknowledging some contrarians among the analyst ranks, Barron's continues "There may even come a day when the bargain-hunting experience loses its thrill. Already, companies are creating the technology that allows shoppers to have their measurements taken at home, and then create the clothes people want without having to search for it...." 

Enter Charming Charlie Holdings Inc. The company filed for bankruptcy earlier this week, capping a bloodbath of a year for retail. For the unfamiliar, Charming Charlie is a Houston-based specialty retailer focused on colorful fashion jewelry, handbags, apparel, gifts, and beauty products. It has 350 domestic stores and a core demographic of 35-55 year-old women. The company blamed (i) "adverse macro-trends" and (ii) operational shortfalls (e.g., merchandising miscalculations, lack of inventory, an overly broad vendor base) for its underperformance and reduced sales. EBITDA declined 75% "in the last several fiscal years." 75-effing-percent! With a limited amount of money available under its revolving credit facility and even less cash on hand, "Charming Charlie is out of cash to responsibly operate its business." Ouch. Two weeks before Christmas. Rough timing.

As it relates to "merchandising miscalculations," this bit caught our eye: "Historically, Charming Charlie utilized a sophisticated inventory system to position products according to their color and theme. Merchandise is offered in as many as 26 different hues and arranged at each store according to the item’s color and theme, creating what has been referred to as a “treasure hunt” experience. While this approach initially provided Charming Charlie with a strategic benefit, and engendered significant brand loyalty, it eventually caused Charming Charlie to be saddled with excess merchandise in underperforming color offerings." Curious. 

Long time PETITION readers know that we love to discuss what we call "busted narratives." Reminder: our focus is "disruption" and not necessarily "restructuring." And we'll acknowledge upfront that we may be cherrypicking one statement in an otherwise lengthy court document. But one ongoing narrative is that off-price "treasure hunt" retailers are safe from e-commerce. We're not so sure. It stands to reason that as things become more convenient at home - with 3D-printing, Amazon Echo Show, Amazon private label (see below), free returns, etc. - retailers will continue to focus more and more on inventory management. That is, if they have inventory at all. Obviously, direct-to-consumer is the not new retail trend and newer brick-and-mortar locations supporting the likes of Bonobos, Warby Parker, etc., are merely showrooms in furtherance of brand enhancement rather than inventory and supply chain management. Indeed, Charming Charlie announced that is reducing its vendor base down from 175 to 80. As inventories are more streamlined, that strikes us as an obvious headwind to discounted "treasure hunt" retailers. After all, they benefit from inefficient inventory management. And, notably, TJX had a relatively rough quarter recently. Now, TJX isn't filing for bankruptcy anytime soon, but query whether this is a trend to watch going forward. Query whether the "off price" narrative holds. 

Some other notes on Charming Charlie while we have your attention:

• The company has also commenced the closure of ~100 of its 370 stores (350 domestic + 20 international), a meaningful reduction in its brick-and-mortar footprint. Note some carefully crafted language, "The Debtors anticipate 276 go-forward locations following the first round of store closures." Key words, "FIRST ROUND." We wouldn't be shocked if the company shutters more. That depends on the landlords, it seems...
• ...and the landlords are getting squeezed too. The company seeks "to amend lease terms to reduce occupancy costs and obtain rent abatements for the first quarter of 2018...." As Starbucks ($SBUX) and Whole Foods ($AMZN) recently discovered, there's a big difference handling leases in vs. out of bankruptcy court.
• The fashion industry has suffered a 15% downturn in fashion jewelry sales and the company experienced a disproportionate 22% decline itself. Query whether the direct-to-consumer model is helping to disproportionately batter brick-and-mortar fashion jewelers.