Dive Brief:
- Moody’s downgraded Michaels’ corporate credit rating this week to B2 from B1 and gave the crafting retailer a negative outlook, indicating the likelihood of another downgrade down the road.
- Analysts cited high freight rates and changes in consumer sentiment spurred by inflation.
- S&P Global Ratings also changed its outlook for the retailer to negative, though S&P held its current rating for Michaels at B for now, according to an emailed release. Analysts with the ratings agency likewise cited operating costs and slowing consumer demand.
Dive Insight:
The retail world has gone through several evolutions since Michaels was acquired by private equity firm Apollo Global Management last year.
Michaels may have been an attractive purchase at the time. It benefited from several pandemic trends. Most importantly was a surge in do-it-yourself and crafting projects during the long slog consumers spent at their homes out of safety concerns. Michaels further capitalized by investing in its e-commerce and omnichannel capabilities, and the retailer reaped triple-digit sales growth in e-commerce in the turbulent days of 2020.
As 2021 unfolded, supply and freight constraints, driven in large part by the ongoing effects of COVID-19 and surging consumer demand, led supply chain costs to skyrocket for retailers. Consumers then had cash to spend while still holding on to some of their pandemic habits, with spending at restaurants, travel and other experiences still down — to the benefit of retailers.
So even while freight and other costs were rising, many retailers could raise prices and maintain strong margins. Much of those trends came to a screeching halt this spring, though, as gas and food inflation weighed on consumers’ wallets at the same time as they began going out into the world more to spend on experiences. And while easing, freight costs have not fully receded.
All of those trends are weighing on Michaels now, according to ratings analysts. S&P noted that comparable sales fell 10% at Michaels during the first quarter (ended April 30) as “lower guest traffic more than offset higher prices.” With consumers pulling back on discretionary spending to hedge against inflation, that trend may continue, analysts said.
Moody’s said that its recent downgrade “reflects the risks of slowing consumer demand as product inflation and higher ocean freight costs [add] pressure to its profitability and credit metrics.”
Analysts with the ratings firm also pointed out that the “vast majority” of Michaels’ products are imported from Asia, forcing the retailer to extend lead times and also causing product shortages, which in turn hurt sales in the fourth quarter.
Moreover, Moody’s analysts noted that Michaels is “exposed to categories that are more sensitive to economic conditions (such as seasonal decor and custom framing), and competition from two other arts and craft chains as well as larger well capitalized big box retailers.”
Also adding pressure to Michaels is the additional leverage the company took on when Apollo acquired it. With sales and profits flagging, the debt load and interest payments are all the more difficult to manage, as scores of retailers that went through leveraged buyouts in the past two decades can attest.
