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Is Bon-Ton Stores Headed for Bankruptcy?

By Adam Levine-Weinberg - Apr 1, 2017 at 10:55AM

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Sears has made all of the headlines recently, but it's not the only department store chain teetering on the brink of bankruptcy.

Last month, Sears Holdings (SHLDQ) made waves by notifying investors in its annual report that it might not be able to continue indefinitely as a "going concern" due to its long history of losses.

Sears' announcement was particularly momentous because of the company's history as an icon of American retail. Yet it isn't the only department store facing a serious risk of bankruptcy. Bon-Ton Stores (NASDAQ: BONT) is another storied department store company that might not be able to survive much longer.

The exterior of a Bon-Ton store

Bon-Ton Stores is barely hanging on. Image source: The Bon-Ton Stores.

Bon-Ton wraps up another bad year

A year ago, Bon-Ton Stores' management projected a 0%-1% comparable store sales gain for fiscal 2016, while stating that gross margin would expand and operating expenses would decline. Based on this forecast, the company expected to post adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of $140 million to $150 million.

However, Bon-Ton missed badly on its revenue guidance. Ultimately, comp sales fell 3.8% last year. As a result, while Bon-Ton exceeded its goal for cost savings and gross margin came in ahead of plans, the company fell short of its earnings forecast by a wide margin.

Adjusted EBITDA totaled $116 million for the full year, or $122.5 million excluding consulting and severance expenses related to Bon-Ton's cost-cutting plan. The company's full-year adjusted loss reached $2.01 per share.

Two distinct situations

While Sears Holdings and Bon-Ton are both in trouble, they don't face the same challenges. Sears has valuable assets, including a big real estate portfolio and popular brands like Kenmore and DieHard. However, the company is burning cash at a rapid pace, with negative free cash flow of $1.5 billion or more in each of the last few years.

The exterior of a Sears store

Sears has sold off a lot of real estate to raise cash in recent years. Image source: Sears.

By contrast, Bon-Ton Stores actually managed to produce $4.3 million of free cash flow last year. That was a huge improvement over fiscal 2015, when free cash flow was negative to the tune of $66.9 million. But Bon-Ton had to cut operating expenses and capital spending to the bone just to turn modestly cash-positive.

Meanwhile, Bon-Ton doesn't have any significant assets to sell if it needs to raise cash. The company leases 235 of its 267 stores. Furthermore, virtually all of its assets are already pledged as collateral for its massive debt load.

More trouble ahead

Management expects sales to continue falling this year. In conjunction with its recent fourth-quarter earnings report, Bon-Ton forecast that comp sales would slip 2% to 3% in fiscal 2017. That said, the company hopes to hold EBITDA relatively flat year over year through additional gross margin improvements and incremental cost reductions.

However, these plans are somewhat suspect. Most notably, Bon-Ton ended fiscal 2016 with way too much inventory. As recently as January, the company claimed that it was on track with a plan to reduce average inventories by 4% to 5%. Instead, inventory was up 1.8% year over year by the end of that month.

Management attributed part of this inventory increase to a decision to accelerate the arrival of warm-weather merchandise, as the northern U.S. (the company's main geography) had a mild winter. But even stripping out this shift, inventory was up 0.3% year over year.

Furthermore, after getting burned by unseasonably warm weather during the winter, Bon-Ton may have been hurt by unseasonably cold weather last month. Winter Storm Stella dumped snow and ice across much of the Midwest and Northeast in mid-March, impacting a large part of Bon-Ton's store footprint.

The combination of having too much inventory and not having the right kind of inventory at the right time could severely impact Bon-Ton's gross margin this quarter. And it can often take a while to correct an inventory glut, so these problems could linger for the rest of the year. If gross margin declines significantly in fiscal 2017, Bon-Ton is likely to miss its earnings guidance badly once again.

Crunch time

Bon-Ton was able to refinance all of its 2017 debt maturities last year despite its poor financial performance. However, the company has hundreds of millions of dollars of debt coming due near the end of 2018.

If free cash flow turns negative again in 2017 and shows no sign of improvement in 2018, lenders may balk at refinancing Bon-Ton's debt next year. After all, Bon-Ton's inability to make long-term investments means its competitive positioning is likely to get worse as time passes. Furthermore, its book value is already negative.

Thus, if sales trends remain weak, there is a significant risk that Bon-Ton will go bankrupt within less than two years. Unless there is a clear light at the end of the tunnel by then, Bon-Ton and the six other department store brands it owns could disappear for good.

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