Five years after its acquisition, 99 Cents Only Stores is facing a crucial moment as the Commerce-based retailer continues to lose money as debt from the deal comes due next year.
Century City’s Ares Management and Toronto’s Canadian Pension Plan Investment Board acquired the then-public company for $1.6 billion in 2012, and have taken on more than $883 million in debt, at a time when the retail chain was profitable and popular with consumers coming off the recession.
Analysts said that since then, in addition to being highly leveraged, the company has focused too much on expanding its store count while ignoring older locations that are losing revenue.
“This is really kind of a make-or-break year for them,” Philip Emma, a senior analyst at Debtwire Inc., said of management.
There was a glimmer of hope in the annual earnings report released by the company last month, which showed sales of $2.06 billion for the year ended Jan. 27, an increase of almost 3 percent from the year-earlier period. Foot traffic and average receipt price also rose. Still, 99 Cents Only reported a loss of $118.2 million, substantial, but an improvement compared with a $248 million loss the prior year. In 2011, its last fiscal year as a public company, it reported a $74 million profit.
The company, whose debt is publicly traded, files financial statements with the Securities and Exchange Commission.
A representative of 99 Cents Only, Ares, and the pension plan declined to comment last week.
Mickey Chadha, senior credit officer at Moody’s Investment Service, said the Ares-led group is running out of time and options to turn a profit on the acquisition.
The retailer’s debt obligations are looming, Chadha noted, with a $595 million term loan that must be refinanced by October of next year, since there’s no chance of the company repaying its debt in full. The company will probably be able to refinance if it continues on its upward sales trend, but he doubted the chain will return to its glory days.
“Ares and the CPPIB paid $1.6 billion,” Chadha said. “They’re not making that back. Either way, they have to take some kind of haircut. Even if they sell later, I don’t know if they’d recoup their investment because the profitability is much lower than it was when they bought it.”
Treasure hunt
Dollar stores have been a generally profitable enterprise for years, existing since at least 1939.
The idea for the 99 Cents Only Store came to founder Dave Gold while running his family’s local liquor shop in the 1960s.
Gold riffed on the idea of a dollar store, injecting his sense of humor and focusing on presentation when he opened the first 99 Cents Only Store in Los Angeles in 1982. After growing substantially, the company went public in 1996.
Like other dollar stores, 99 Cents Only did well during the recession, attracting the attention of investors. Backed by private equity firm Leonard Green & Partners, the Gold family made a $1.3 billion offer to take the company private in 2011, but were outbid by Ares, a publicly traded alternative investment manager with almost $100 billion in assets under management, and the pension plan, which is owned by the Canadian government and manages almost $300 billion.
The company’s new co-owners set out to scale the business, growing store count to 390 as of January from 285 pre-acquisition. But as they did so, same-store sales suffered.
“They were so focused on new-store growth, they were not focused on profitable growth,” Chadha said. “They were opening all these stores but not making any money.”
During this time, management adopted a strategy of filling their stores with ever more merchandise. The plan backfired when the chain was unable to move the new items, and the company was left on the hook with the inventory, which it had to sell at a discount.
After some executive turnover, 99 Cents Only named grocery veteran Geoffrey Covert, a former executive at Kroger Co., chief executive in September 2015. Under Covert, the company decreased inventory by $20 million, while generating more revenue.
The chain has started renovating its buildings as well, which it plans to do at all locations eventually.
Positive news has followed the changes, resulting in the last fiscal year delivering a 2.1 percent increase in same-store sales, a 0.4 percent jump in foot traffic, and a 1.7 percent rise in average ticket price, according to its recent earnings report.
Dollars, debt
Analysts expect the dollar-store segment to continue its growth, fed by more middle- and high-income consumers who have yet to abandon the stores they found during the recession. About 19 percent of the segment’s sales were from households with income over $100,000 last year, according to Marshal Cohen, retail analyst at NPD Group.
“When the more frugal customer discovers the dollar stores, they realize they can buy a pair of scissors for $2 instead of $12,” Cohen said. “It’s like treasure-hunt shopping.”
At the same time, people with less money are also remaining loyal as wages have largely remained flat.
But that won’t necessarily give an edge to 99 Cents Only, which is significantly smaller than publicly traded competitors Dollar Tree Inc. and Dollar General Corp., both with market capitalizations around $20 billion.
Dollar Tree and Dollar General are planning to expand to California, making 99 Cents Only’s lack of diversity in locations a potential liability, according to a Moody’s report.
And its debt problem isn’t going away.
The company is one of an increasing number of retailers struggling under the weight of debt accumulated from leveraged buyouts.
According to a February report by Moody’s, the number of retailers offering distressed bonds has tripled since 2011, approaching recession levels. Those companies include Vernon upscale jean seller True Religion Inc., for which TowerBrook Capital Partners paid $835 million in 2013 and which analysts expect to default on $471 million in debt this year or next, and Payless Shoesource Inc., purchased by several private equity firms for $1.3 billion in 2012, declared bankruptcy last month.
“Private equity’s aim is to grow the size of a company, get out in five years, and make money,” Chadha said. “Except (Ares and the pension plan) paid so much for the company, it didn’t come out that way. There’s not a lot of room for error when you have a highly leveraged company.”
