DEALWATCH: US Retailers Should Start Hawking Equity

It's time retailers took a cue from their REIT counterparts and considered raising equity to bolster their balance sheets.

Since March 9, both the S&P 1500 Real Estate and S&P 1500 Retailing indexes have gained around 45%. However, that's where the similarity ends between the two sectors. While 23 U.S. real estate investment trusts have capitalized on these gains and raised equity, so far no retailer has taken the opportunity.

Indeed, prima facie, REITs have a greater need to issue equity as they carry more debt on their balance sheets than retailers. However, retailers carry significant off-balance-sheet debt in the form of operating leases on the real estate underlying their stores.

Before adjusting for these leases, the average net debt-to-market-cap ratio for companies in the S&P 1500 Retailing index is 0.47x, versus 1.86x in the S&P 1500 REIT index. When adjusted for the operating leases, that number jumps to 1.90x, surpassing that for REITs.

On top, retailers' earnings are susceptible to external factors such as fashion trends, weather and discretionary spending, which makes their business model riskier than that of REITS, which rely on steady rental income.

Timing may prove crucial here as it's questionable if the current rally in retailer stocks has legs. So far, it's been driven by better-than-expected earnings. However, the results have been achieved in part through aggressive cost-cutting as opposed to top-line growth.

Actually, several retailers, from high-end department stores to mass discounters, continue to report significantly negative same-store sales trends.

Retailers that could benefit from equity issuance include companies like Group 1 Automotive Inc. (GPI), which has seen a 96% rise in share price since March 9 but has an adjusted net debt/next-12-months Ebitdar (earnings before interest, taxes, amortisation and rent) of 10.55x. Foot Locker Inc. (FL), is another example; its shares have risen 57%, and it has an adjusted net debt/NTM Ebitdar of 5.41x. Also, shares of Sears Holdings Corp. (SHLD) have risen 56% since March 9, and the company has an adjusted net debt/NTM Ebitdar of 4.21x.

The reticence on the part of retailers to issue equity despite the current rally may be due to the fact that most stocks are still trading well off their 52-week highs.

However, the current capital market window could close quickly if end-consumer demand fails to pick up in coming months and retailers run out of areas to cut costs. Even retailers that think they currently have the appropriate capital structures could be at risk given the high operating leverage of these businesses.

(Sameer Bhatia is a columnist with Dow Jones Newswires. He brings over seven years of experience in the investment banking industry advising clients in sectors including consumer, retail and beverages on capital markets, valuation and strategic issues. He can be reached at 201-938-5863 or by email at [e-mail]. Dow Jones Newswires is enhancing its news, commentary and analysis for the investment banking community, and is providing it on this service temporarily. Stay tuned for information on continued access to the best of Dow Jones news and opinion on companies, sectors and deals for bankers and research analysts.)

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