In this week’s Commercial Awareness update, we discuss the Fed, interest rates, Thomas Cook’s liquidation, Sainsbury’s cost cutting plans, Nike’s record share price and Forever 21 files for bankruptcy protection.
Fed pumping money into the banking system
In the last two weeks the US Federal Reserve (the Fed) has announced a rate cut as concerns about the American economy grow, and the trade war with China starts to take its toll. As expected by many commentators, the Fed lowered the target range for its key interest rate between 1.75% and 2% (a drop of 25 base points or 0.25%). This follows a number of other countries dropping their interest rates to stimulate the economy (see previous update). Between 2017 and early 2019, the Fed had been increasing rates rapidly as the US economy appeared to be going from strength to strength, however recent figures suggest the economy is stalling despite current projections predicting the economy will grow at a slightly higher rate than was forecast at the beginning of the year (2.2%).
The rates cut was expected by most, but it was another intervention which got the financial press talking this week. In the repurchasing (repo) market, the Fed took the step to inject funds to keep it running effectively. The repo market is used by banks and other organisations to borrow cash in exchange for a similar value of securities, often Treasury notes, in the short term to cover costs of transactions. They will borrow the cash cheaply because the lender has the securities as collateral, and will effectively agree to buy back the securities at a later date. This enables the financial markets to run effectively, and allows businesses to easily access cash when they need it.
However, in recent times the repo rate has risen, making it more expensive to get capital in the short term. This usually happens when there isn’t enough cash in the system and demand is high. Earlier in the week, data showed the repo rate reached 10%, which is well above where it normally sits. The Fed stepped in with measures to inject $75 billion in the market to reduce rates. and whilst this worked, some commentators suggest this level of intervention is worrying for the system.
Questions to ask yourself... What are the key signs of a potential recession? What other measures can the Fed take to boost the economy?
Companies to watch
Travel agent, Thomas Cook failed to secure the £200 million it needed to keep afloat and entered liquidation earlier this month, after talks with the government and creditors broke down. Founded in 1841, it served 19 million customers and had an annual revenue of £9 billion in its peak. Earlier in the year, the firm had reported a £1.5 billion loss for the first half of its financial year and it had a debt of £1.6 billion. It had put itself up for sale and was talking to banks about an emergency loan to keep operating, but they weren’t able to secure the funding they needed to continue. The collapse led to 150,000 British citizens left abroad without a means to come back, a significant task for the British government to deal with. Each holiday package with a flight is sold with ATOL protection, which means there is a fund available to support this effort.
Thomas Cook has been on the brink of collapse before and has needed rescue deals to continue operating. In both 2011 and 2013 capital has been injected into the business, which is potentially why investors were put off this time. In 2007 its share price was at 275p and after a rocky decade, it crashed in 2019 after the turnaround plan looked doomed. Many look towards the poor running of the company or the acquisitions it made, but the key may lie in the lack of modernisation. Thomas Cook were an old school travel agent in an age where people could easily put together their own holidays online.
Sainsbury’s has taken the decision to close 60 to 70 Argos stores in the UK as they aim to cut costs from the business. They’ve taken the decision to move them inside their regular stores, but some of these will also face closure as part of a plan to reduce costs by £500 million over the next five years. Sainsbury’s has warned investors that profits had dipped over the last six months, which is a common trend the high street retail sector. With real estate becoming more expensive and footfall in many areas declining, as more shoppers move online, store closures are becoming more widespread. As part of the cost cutting exercise, Sainsbury’s Bank will stop selling mortgages, which is a move Tesco also made. With interest rates so low, there’s less profit to be made from mortgages, hence the decision.
Sainsbury’s are also in a tricky position in their core grocery business, as discounters Lidl and Aldi take increasing market share. They want to keep their prices low to fend off these insurgents, but it’s difficult to maintain a healthy profit margin with these restrictions. It’s not all gloom for the store however, as they will be opening new stores across the UK in the coming years as part of their new plan.
Sports and fashion giant company Nike hit a record share price last week after earning results beat Wall Street’s expectations. On Wednesday the share price jumped 6% after results on Tuesday evening showed they made quarterly revenues of $10.66 billion, compared to the forecasted $10.44 billion. The markets were especially enthused by the 27% year on year growth in the Greater China market. There were also improvements in their gross margin, which stood at 45.7%. The retail sector is a particularly tricky market currently, but Nike’s online offering is growing rapidly under its new strategy.
It was a very different picture for Forever 21 this week, after the retailer filed for bankruptcy protection in the US and plans to close down all operations in Europe and Asia. Stores in the UK will be placed into the hands of administrators. Competition from the likes of Zara and H&M have led to declining fortunes for the company. Globally, the company plans to shut down some stores and restructure its finances to continue operating.
Questions to ask yourself... Could anything could have saved Thomas Cook? What are successful retailer doing well in the current market?