Distance to Default: the growing divide between retail’s haves and have nots

KPMG’s FY17 biannual Distance to Default (D2D) analysis, across more than 2200 ASX companies revealed interesting results, none more so than the emergence of a much larger gap in D2D scores between retail’s big winners and the big losers.

With media speculation on the impact of Amazon’s entry to Australia continuing to make headlines along with a subdued consumer confidence, using our D2D analysis, we sought to delve deeper into the default indicators of one of Australia’s the most disrupted sectors – retail.

D2D: It’s a telling indicator

The idea behind KPMG’s D2D analysis is simple. The closer a D2D score is to zero, the more likely a particular industry or company is to default. In contrast, the further an industry or company’s D2D score is from zero, the less likely it is to default (on a scale of zero to five). In this analysis the average score has been calculated for each sector and we conduct this analysis on a 6 monthly basis following completion of the reporting season each half and full year.

Widening disparity between those who are ‘in’ and those who are ‘out’

The Retail and Consumer Market average D2D score declined from 2.40 to 2.28 from December 2016 to June 2017, defying the ASX overall improvement in the score with a widening gap between the haves and have nots. Whilst food and staples retailing is performing significantly above the ASX average D2D score, their D2D score has slipped with pressure from the highly competitive pricing environment. Industries including distributors, textiles, apparel and luxury goods, specialty retail, internet and direct marketing all reporting below ASX average results.

Within retail and consumer markets there was an 8 percent increase in the portion of the industry group performing below the ASX average D2D score, from 44 percent of companies at December 2016 (52 companies) to 52 percent of companies in the industry group at June 2017 (64 companies). The trend now sees over half of companies in the Retail and Consumer Markets industry group trending below the ASX average.

Pressure is particularly evident across companies in the Distributor and Specialty Retail industries. This decline may reflect retailers looking to sell direct to customers rather than wholesale through distributors, which typically generates a higher margin and stronger brand control. Given the squeeze on discretionary spending, specialty retailers are struggling to stay relevant unless they have a strong omni-channel and in-store experience.

With clear ‘haves’ and ‘have nots’ emerging, and in the lead up to Christmas, retailers have rarely been under more pressure from more sources. Our findings reveal those on the edge need to: re-consider their strategy, review their locations, really know their customers, and consider how they are going to fund the investment needed to stabilise their business amid increasing pressure on margins and overseas competition. Those retailers relying on a bumper Christmas may be disappointed. There is little to indicate consumers will be anything less than savvy given that pre-Christmas discounting of inventory has become something to expect and consumers growing appetite (up 16 percent on last year) to buy their Christmas goods in advance on the Australian Black Friday and Cyber Monday sales.

Restructuring is likely to become the new norm over the next 3 years

The Financial and Real Estate sectors continue to display the highest D2D scores, indicating strong corporate health, and the Energy sector continues to have the lowest D2D score. Whilst the ASX average D2D score shows an overall improvement in corporate health, close to half of respondents from larger Australian companies to KPMG’s 2017 Evolving Deals Landscape survey are looking to implement specific performance improvements, restructuring or turnaround initiatives in the next 3 years (36 percent for mid-sized companies).

There are also companies that are far from distress considering turnaround strategies to extract further value from operations. For a growing number of these businesses, restructuring is an opportunity to ensure they are operating at their most efficient level in response to increasing economic and financial pressures.

Analysis of companies listed on the ASX using the D2D score can help detect deteriorating corporate health, and hence increasing default risk, because such analysis incorporates more forward-looking information than other data sources such as financial statements. We have continued to refine our analysis in this our second edition of Distance to Default to ensure we provide an effective financial metric to be used to determine the sectors with higher default risk. We hope you find the read worthwhile.

Read the full report, Distance to default: a default indicator for Australian-listed companies Vol.2


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