In April, Gold’s Gym proactively closed 30 company-owned gyms; and by May, they declared bankruptcy. In making that decision, it meant that they separated themselves from “nearly 700 gyms around the world.” J.Crew joined them by filling for Chapter 11 protection in early May.
Since then retailers have either gone bankrupt or filed for Chapter 11. In the US, Neiman Marcus, J.C. Penney, Tuesday Morning, PQ New York, Lucky Brand, Brooks Brothers and Sur La Table. In Canada, David’s Tea, SAIL Outdoors Inc, Henry's and Aldo did the same.
The 85 year old vitamin company called GNC saw a 30% drop in their store sales; while 24 Hour Fitness couldn’t provide their chief product - a place to exercise. Both filed for bankruptcy in June.
While, in the same month, CEC Entertainment - a company which owns 550 Chuck E. Cheese and Peter Piper Pizza locations - after COVID lockdowns found itself doing an oxymoronic and/or paradoxical thing: on one day, they both reopened 266 venues and filed for bankruptcy protection.
But it doesn't end there. Reitman’s is a multi-brand flagship fashion retailer. Before the pandemic, they owned 5 different brand subsidiaries: Reitmans, Penningtons, RW & CO, Addition Elle and Thyme Maternity. Now they are in the process for filing for bankruptcy. Reitman’s will be permanently closing Addition Elle and Thyme stores; and will be reducing the number of Reitmans, Penningtons and RW & CO outlets.
Or think of Ascena Retail Group, Inc. You might know them as Ann Taylor, LOFT, Lou & Grey, Lane Bryant, Cacique, Catherines or Justice. Or put differently, Ascena Retail Group, Inc is a provoyeur of girl’s and woman’s fashion. They were a member of the S&P 600 and listed on the Nasdaq Stock Exchange. They operated in Canada, the US, Puerto Rico and Mexico. Ascena filed for chapter 11 in July.
From Energy to Entertainment. from Health and Personal Care, COVID has impacted a huge and diverse range of companies. It has stopped firms who provide travel services, those who provide lodging, those who enable us to seek leisure as well as firms who make things and mine. Who could have imagined a company like Hertz going bankrupt? After all, all they did was rent cars. How could you go bankrupt doing that? Well, stop people from travelling and you have an answer.
These brief stories don’t fully explain the problems that businesses - small, medium or large - have had during this COVID-19 pandemic. However, the question as a retail investor is simple: what do we do?
The usual rule is to stay invested. In usual times, we are told that markets go up and down and that they will recover. This is true. One doesn’t have to think hard to realize that many businesses including CN, CP, Bank of Montreal and SunLife have survived epidemics, floods, wars and the Great Depression. COVID 19 will not be the end of Canada, the Canadian Economy or Humanity.
However, as we have seen it will be the end of some companies, some partnerships and some businesses. Or put differently, most companies or firms don’t have a large amount of savings. Since the 1950’s, many businesses have increasingly been dependent on cash flow to get them through the business cycle. In 2008, we saw that this was a problem. Some businesses learned their lesson, but others didn’t. In a pandemic where sales and cash flow will be strained many companies will find themselves in trouble. So as a retail investor, this is time to take stock and be cautious.
While one should not get out of the market, this is a time to reduce your bankruptcy risk. How does one do that? There are two ways. The first way is to look at financial instruments which are pooled or mutualized.
What do I mean by that? Think of financial instruments which depend on more than one company to gain their value. Segregated Funds and Mutual Funds provide two good examples. These funds are managed by professionals who buy a portfolio of stocks and/or bonds. Those portfolios are then subdivided into smaller pieces that investors can then buy. If a segregated or mutual fund has 20 to 40 different companies in the portfolio, the bankruptcy of one or two companies will likely have a small impact on the overall portfolio.
If you want an example, we can use the example of Nortel. A Canadian company, it filed bankruptcy in 2009. At its peak, in 2000, the company’s stock price was $124.50. Yet, by December of 2008, the firm had lost its listing on the New York Stock Exchange because it had a value of less than $1 USD for more than 30 days. By the time, the Toronto Stock Exchange delisted the stock on June 26, 2009 Nortel stock had a price of $0.185 CAD. One can see easily that an investor in that stock would have lost a lot of money. But as a mutual fund investor, one might only be exposed to 1/20 or 1/40 of the risk of failure. Since a mutual fund investor would have 20, 30 or 40 more companies in their unit, the bankruptcy of one company is not too burdensome.
Canadian Investors learned the same thing when the Harper Government changed the rules around Income Trusts; in 2008 when CIBC was hit by the US Banking Crisis; or in 2018, when SNC Lavalin started losing contracts worldwide: investing directly in companies exposes one to more risk. Sometimes, this risk can be rewarded; but in these times, it usually isn’t.
The second way is to use those financial instruments which are higher up the bankruptcy totem pole: bonds and preferred stocks. Usually, bankruptcy happens because a company doesn’t have enough cash or cash flow. To ensure that a company’s creditors and/or stakeholders are paid, the bankruptcy process is a way of divesting the company. So, it is easy to see that bankruptcy has an uneven effect on different financial instruments.
If there is enough money to pay out the creditors and/or stakeholders, most of the Western World has an order for the remaining investors. The first on that list are the bond holders. Bondholders are the most like other creditors because they have left the bankrupt company money. For each bond is like a retail loan, line of credit or mortgage: it is a promise to pay back the holder of the bond/debenture over a certain amount of time.
After that comes the preferred share owners. Preferred shares are “limited” owners of a company. They don’t get the rights to claim the equity upon dissolution but they do get voting rights or extra dividends under certain circumstances.
Only after preferred share owners and bondholders are paid out do equity owners get to see anything. Accordingly, the bankruptcy of a firm will usually whip out those equity shares which represent the most direct ownership of the firm. Also called voting, ordinary or common shares equity shareholders normally get to decide the future of the company. They receive the profits in good times. Consequently, it is not a surprise that if they would also receive the value of the company if the company was wound up in a positive fashion, they would be the first to lose when a company goes bankrupt.
With that in mind, it is easy to see why one would rather be a preferred shareowner or a bondholder today. With the risk of bankruptcy high, why be the one holding the bag when the music stops? For most retail investors, it is hard to hold a portfolio of bonds or debentures; however, there are other options. While the returns are not great, GICs are largely investment grade bonds. However, that is not the only option. As I mentioned earlier, bonds can be added to or be the exclusive component of mutual funds or segregated funds. There are also bond ETFs and other pooled assets which are bond dependent.
One which you might not think about would be a Whole Life Insurance Plan. While unconventional, permanent Whole Life Insurance Plans are often driven by an underlying portfolio which includes bonds, property and mortgages. Professionally managed, many of the funds managed are managed by firms which have survived the Boer War, the Influenza Pandemic of 1919, the Great Depression and World War One and Two. Given that firms like SunLife, ManuLife, Canada Life, Foresters and Industrial Alliance have survived those calamities, one might think that they will survive this one.
So, if you want my COVID investing advice, remember one thing: reduce your bankruptcy risk. Unlike many other times, bankruptcy risk is real and will be constant for the next few years. Keep to products and investments which minimize that risk. Keep to pooled or mutualized products or products which are higher on the bankruptcy totem pole. If you take this advice, I promise you that five to ten years from now - when COVID 19 is history or seems like a bad dream - you will be further ahead.
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