Are these retail sector stocks about to run out of cash?

Cash piles could disappear fast if stores keep paying suppliers on time, so they may have to do this. 

Finding retailers with the resources to ride out Covid-19 will be an urgent priority for many investors when shares like Next (LSE:NXT), JD Sports Fashion (LSE:JD.) and Marks & Spencer (LSE:MKS) are trading 35% or more lower than since the start of the market sell-off.

Analysts at Morgan Stanley have taken a closer look at the financial liquidity of retailers, with particular focus on what happens to cash reserves should they continue to pay suppliers on schedule.

The research suggests that the average time retailers could cope without additional financing falls to just 11 weeks, compared with an average 47 weeks when payments to suppliers are withheld.

While both scenarios are overly bearish in assuming no revenues, they do highlight how significant the timing of supplier payments is going to be in analysing retailers' liquidity.

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Morgan Stanley said:

“The dilemma as to whether or not to pay suppliers on schedule is an unenviable one for retailers and few have revealed how they intend to approach it.”

Given that most retailers will not want to damage their reputations with suppliers, customers and Environmental, Social, and Governance (ESG)-focused investors, it is likely that the preferred option will be to raise fresh equity. This approach has already been taken by WH Smith (LSE:SMWH) and AIM-listed pair ASOS (LSE:ASC) and Joules Group (LSE:JOUL, with others expected to follow suit in the coming weeks.

Source: TradingView Past performance is not a guide to future performance

To find out the benefit of this approach, Morgan Stanley has added liquidity equivalent to 15% of current market capitalisations to each of the companies that it covers.

They said:

“This analysis suggests doing so could make a material difference to some retailers' ability to ride out the Covid-19 storm, but would help little at others.”

Across the bank's Europe-wide coverage, it finds that 15% equity raises would approximately double the amount of time that some retailers could cope with having no revenues.

Next (LSE:NXT) and Pets at Home Group (LSE:PETS) would be among the beneficiaries, whereas the amounts that could be raised at Dixons Carphone (LSE:DC.) would still be dwarfed by the payments due to suppliers.

Kingfisher (LSE:KGF), M&S and Ted Baker (LSE:TED) are also unlikely to see much benefit, compared with the more than 20 weeks cash cover with an equity raise for Dunelm (LSE:DNLM), JD Sports, Primark owner Associated British Foods (LSE:ABF) and Boohoo (LSE:BOO).

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Morgan Stanley admits there are limitations to its research, not least that it assumes weekly payments to suppliers will continue indefinitely.

In reality, these would cease after 10-15 weeks as all stock would have been paid for by then.

However, it does highlight the prospect of more equity raises similar to last week's £247 million fundraising by ASOS, which was followed by a 40% share price surge.

ASOS shares are still 30% lower since the start of the market slump, compared with 45% for Dixons Carphone and Marks & Spencer, 35% at Next and 39% for JD Sports Fashion.

Source: SharePad as at early afternoon 15 April 2020

It's also worth remembering that market rules prevent companies increasing their share count by more than 20% without the time-consuming process of publishing a prospectus.

Many retailers are also not likely to be eligible to borrow from the government's emergency Covid-19 schemes due to a requirement for companies to have investment grade ratings.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.