Is Charming Charlie's Bankruptcy a Canary in the Coal Mine?

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.

Feature of the Week: More Earnings (Simon Property Group & Starbucks)

This past week was an earnings-fest with Amazon and Google pumping out redonkulous numbers, Vince Holding Corp. missing estimates by 10 cents, declining 26% and continuing its slide towards bankruptcy, and FTI Consulting missing estimates BADLY, declining 3% and charting -23% year-to-date (we wonder how Berkeley Research Group is doing?). While all of these reports were intriguing, we took particular interest in reports from Simon Property Group and Starbucks...

Simon Property Group

Upshot: increased net operating income, increased retail sales per square foot, and increased average base rent. The company reported a flat occupancy rate of 95.6% at Q1 end and affirmed it's previous '17 guidance (typically, the company raises guidance). Snoozefest, we know, but keep reading...

CEO David Simon had a number of choice things to say about the current state of affairs (PETITION commentary follows in italics):

• Retailers need to improve the in-store experience via technology, look and feel, and merchandising. He straight-up called his tenants to task alleging that they are overspending on the internet vs. the store fleet. He says this is reversing back and notes that pure e-commerce will need brick-and-mortar. Ironically, most recent bankrupt retailers claim that they filed for bankruptcy because they hadn't focused on their e-commerce fast enough! We can't recall one bankrupt retailer who cited too much expense associated with e-commerce as a cause for filing. He also makes no mention whatsoever of Amazon and Walmart's increased market share in clothing, the rise of mobile e-commerce, the rise of platforms, and millennials' lack of interest in shopping (and penchant for vintage clothing). 
• A lot of the current bad performance is driven by private equity leverage rather than the common theme, the internet. He expressly calls out dividend recaps. No quarrel here whatsoever and more victims of this are in the bankruptcy pipeline. 
• SPG has lowered apparel in its retail mix by 5-6%. Whether that was elective was not clear.
• Expect more discounters like TJ Maxx and HomeGoods and grocers like 365, Wegmans and Fresh Market in high end malls. Other specific new tenants include restaurants (Fig & Olive, Nobu) and several movie theater brands with the occasional Dave & Buster's thrown in for good measure. This all seems consistent with the narrative that more experiential-oriented tenants will fill these spaces. Query how long until and to what degree the pain in the grocer segment will come to roost, if at all.
• Because these long-term anchors aren't driving foot traffic and revenue to the malls, there is a lot of upside in reclaiming and redeveloping department stores for mixed use, lifetime or community-oriented activity. They are actively taking back space from unproductive retailers and they are "not putting good money in the rabbit hole," suggesting, at least, in part, that future Aeropostale-like deals are unlikely. Note, also, Aeropostale's performance shaved several basis points off performance and is likely to continue doing so through Q4. This sure sounds like a solid counter-narrative but won't this eventually boil down to a case of volume assuming the vacancy rate next quarter is lower than this quarter?
• Store closures in a market also kill internet sales for that business in-market too. Really interesting and speaks to the thesis promoted by the likes of Warby Parker that some retail presence helps scale.
• Expect improvements in technology in the mall environment. If people had an issue with Unroll.me selling their data, wait until the beacons scale! 
• The mall "traffic is there" and the retail apocalypse "narrative is way ahead of itself." Yet, he wouldn't provide traffic data noting that there aren't traffic counters in their malls. The parking trackers at their outlets, however, are up 2%. See also Starbucks below.
• The strong US dollar has had a significant impact on spending by international tourists. So has our President but we won't go there. Oh, wait, we just did. Not a political commentary: just a plain fact.
• He would not opine as to how much per capital retail needs to come out of the system. It was abstract but, as we noted last week, Vornado Trust's CEO noted somewhere between 10-30% in the next five years.

Macro narrative aside, Mr. Simon remained upbeat about SPG's quarter and guidance. But speaking of REITS, we'd be remiss if we didn't point out this doozy of a red flag piece by the WSJ, highlighting 10 retailers that S&P Global Market Intelligence has noted as at high risk of default: Sears Holding Corp. (for obvious reasons), DGSE Companies Inc. (millennials don't buy precious metals, apparently), Appliance Recycling Center of America Inc. (millennials haven't been buying homes, apparently, so no need for recycled appliances...?), The Bon-Ton Stores Inc. (specialty retailer massacre), Bebe Stores Inc. (what? nobody wants glittery hats and shirts shouting BEBE anymore?), Destination XL Group Inc. ("our financial condition is extremely healthy" says the CEO whose company has a projected net loss on $470mm of revenue), Perfumania Holdings Inc. (mall-based perfume including the foul-stench of the Trump family...also fact, just saying), Fenix Parts Inc. (doesn't Amazon have an auto parts reselling business? why, yes, as a matter of fact it does), Tailored Brands Inc. (tons of quality tuxedo options online these days), Sears Hometown and Outlet Stores Inc. (obvious).

Of SPG's top 10 anchors, Sears is #2 with 69 locations and 11.3mm square footage of space and The Bon-Ton Stores Inc. is #10 with 8 stores and 1.1mm square footage of space. Macy's is #1 with 121 stores and 23.1mm square footage. Top in-line stores? L Brands, Signet Jewelers and Ascena Retail Group - all of which are reporting rough numbers of late. Which may explain why, in the end, SPG's stock was down this week, is down for '17, and is close to its 52-week low. 

Starbucks

Starbucks is just fine from the restructuring community's perspective. With one exception: Teavana. The company indicated that it is "evaluating strategic options." Why? Good question and, quite frankly, the answer is very much at odds with what Mr. Simon says. See, Teavana is a mall-based retailer; it has 350 locations. And they're not faring well predominantly because, per Starbucks' CFO, there is dramatically reduced mall traffic. Accordingly, Teavana has been suffering from negative same store comps and operating losses "for some time" with the rate of decline over the last 6 months far worse than forecast. Now even further declines are expected. And so we did a quick check: there are 78 Teavana locations in Simon Properties which would be 22% of all Teavana locations. Is it possible that those locations are the outliers and are performing extremely well on account of steady foot traffic? Starbucks doesn't break out numbers of a per location basis. But we highly doubt it.