Summary
As Finlay's earnings decline a growing interest bill may make default inevitable. Here's why bondholders could lose more than half their initial investment.
Analysis
Finlay Enterptises lowered its 4th quarter earning estimates after announcing substantially lower sales during the November-December holiday period. According to Finlay, same store sales declined 5.9% during the period, but thought sales could improve in January. With about 2/3 the month in the till, most retailers have indicated that sales haven’t picked up in January. That means Finlay could miss its revised 4th quarter earnings estimates of $1.50-$1.60 per share.
Indeed, earnings could be worse for Finlay. Last year Finlay got a big sales bump as shoppers bought Valentine's Day gifts early. This year, Finlay is not only up against difficult year over year comparisons, it has weaker demand and higher jewelry prices to contend with too. If the company’s sales meet their latest projections, they will lose between ($0.99) and ($1.09) before any year end adjustments. That loss could be considerably more if January comp store sales fail to meet projections.
That raises the question of liquidity. Presently Finlay has a big interest bill coming due on the $200 million in bonds it used to pay for the Bailey, Banks, and Biddle acquisition, as well as, interest and principal on that portion of the $550 million revolver it used for working capital. As of the end of November, Finlay could have had more than $650 million in debt on its balance sheet. That probably equates to more than 50 million in interest when annualized for 2008. With the economy softening and luxury retail sales declining, the BB & B bond holders have to be worried about a Finlay default.
If the company does default, bond holders may be caught in the middle. Any default could trigger a cross default for the bank loan. With about $650 million in inventory, banks would be relatively whole; having a first charge against the inventory. That’s especially true if the big department stores bought the lease department inventory from Finlay as they took the jewelry business in house to protect their own sales base. That would leave about $200 million in inventory value to secure bond holders investment, interest bill, and liquidation cost. But with no ready buyer for the remainder of the jewelry, bond holders would have to settle for the proceeds from a liquidation sale through the Carlyle, Congress, and Bailey, Banks, and Biddle stores. Just what the net proceeds would be is uncertain, but realistic estimates range from $0.30 to $0.50 on the inventory cost dollar.
Debt traders had optimistically thought 90%-100% was the likely recovery amount, but that assumed nearly 100% of the inventory could be sold at 50% of retail which was never realistic then and even less so in today’s economic environment.
