Capitalist Investor

Implications of Small Business Bankruptcies, Ep. 274

Strategic Wealth Partners

1. Rising Bankruptcy Rates:
While still below pre-Covid levels, bankruptcies have increased by 16% year-over-year, with small business bankruptcies up a staggering 60%. The rate of change is alarming and may signal future economic troubles.

2. Notable Bankruptcies:
The hosts discussed several high-profile bankruptcies, including Red Lobster, which had accumulated $1 billion in debt, and Express, a consumer discretionary teen apparel brand. These cases illustrate the challenges faced by companies in adapting to changing consumer preferences and managing debt.

3. Solar and EV Companies Struggle:
Many solar and electric vehicle (EV) companies are facing bankruptcy due to a combination of factors, including high technology costs, lack of consumer demand, and the need for financing. Government incentives have not been enough to sustain these businesses in the long run.

4. Housing Market Concerns:
Lumber Liquidators, a flooring company, recently went bankrupt, highlighting the slowdown in home sales and renovations. Some home builders are acting as banks by offering self-financing options, which could lead to further issues if the economy continues to decline.

5. The Impact of Interest Rates:
The rising cost of borrowing money, with interest rates increasing from 1-3% to 8% or higher, is putting pressure on businesses across all sectors. This squeeze on margins is catching up with companies that may have taken on too much debt during the low-interest rate environment.
The hosts conclude that while the current situation may not be the end, it could be the beginning of a more significant "wipeout" as the Federal Reserve continues its efforts to cool off the labor market and combat inflation. The extent of the damage and the Fed's response to interest rates when things do break remain to be seen.

Welcome to today's episode of the Capitalist. Sylvester, you have me, cool hand Luke, and you have tZ, Tony the Tiger. Yeah, baby. Jealous? Yeah. Always, always jet setting, jet center. He's like Rick Flair of the office. Whoo. Whoo. So we have a pessimistic topic today, which maybe could be optimistic if you change it to that. But we are talking about bankruptcies. We're talking about bankruptcies on large corporations, small businesses, and specifically notable bankruptcies and kind of the story it tells for the environment we're in and what's going to happen going forward. So I'll start off by saying over the past, maybe, let's call it this year, 2024, maybe even the past year, end of last year. Is there anything notable, Tony, like big names, firmsen that you've seen in the headlines? You're like, that's interesting. Like, they went bankrupt. Like, I was not expecting that. Anything that you've seen. Well, all right. So let's just take a look at the numbers. I know that you may, you made mention that, you know, small businesses are up 60%. Yep. Year over year over year. I saw a statistic that bankruptcies are up 16% year over year. But we are still at the pre Covid lows. So like, you know, like there's not as many as there was pre Covid. Right. But you and I are talking about the rate of change. Like, it's starting to accelerate. It's like the unemployment, we go back to the unemployment rate, like 4.1%. Unemployment's historically extremely low, but the fact we rose from 3.5% to 4.1% a matter of couple months. The rate of change is concerning. Same thing with bankruptcies. How quickly it's starting to turn. It's like, is this a signal for the future? Yeah. And if you don't exactly, is it a signal, you know, what is being done to help decelerate that? Those rates of change either slow it down or stop it or whatnot. But it is concerning. And there's a couple companies that came to mind, infamous red lobsters going out of business. But they had a billion dollars in debt. And you can't have all you can eat and shrimp anymore. Okay. I mean, I don't know how you didn't see the writing on the wall on that one. But, you know, that's what they claim the problem was like, oh, yeah, the endless shrimp buried us. Like, so a billion dollars in debt, like that doesn't happen over a quarter a year or two years. Like, that's a lot of debt. So from my understanding, and I want to just dig into this one specifically, very quickly, from my understanding, a PE, private equity firm came in, bought up Red Lobster, and they separated the companies into two. And you basically had the restaurant red lobster, and then you had the real estate real estate lobster. So essentially, the red lobster restaurants went out of business and bankrupt, essentially, is what's happening. But their real estate business is still operating. So basically, they're wiping out all the debt the restaurant has, but they're keeping the real estate. So this private equity firm's coming in there and actually making a ton of money because they're keeping the real estate side, and they're going to be able to flip that real estate or do something. Are they really, though, like, the commercial real estate is not selling. There's. There's a lot of restaurants going out of business because, I don't know, it's just like, it's too expensive to go eat, right? I mean, I know it's. It's weird. I was having this conversation. It's always like, Longhorn has to be killing it. They're always busy. Texas roadhouse always looks. Damn rolls always in that butter, that, that, that, like, cinnamon butter swimming, that stuff, man. I have one friend that says they go up there and just ask for two tubs of butter and take it home. But anyway, that's what I would do. But so as these restaurants close, I think less people are actually going out to eat. Or maybe just red lobsters. Just seeing its time, you know, like, they just lost their, you know, there's more steak and burger places opening than seafood places. Like maybe the new. Maybe the new palate is not seafood. No, it's chicken wings. Chicken wings. And burgers. And smash burgers and steaks. Right. So american way. Honestly, it could just be a trend. Maybe it's not them in general or something they did. It could just be a trend that they couldn't stop. Yep. So you have. But this whole real estate thing is. That blows my mind because, I mean, look at Macaroni Grill. I think they close, too. They're empty still. The ones that I've seen go out of business, they're. There's nothing new jumping in. Well, it's like the. Not to get too off on just one tangent here, but, like, the McDonald's is the. Is kind of similar to how rit rid lobster probably was built. McDonald's is not a restaurant company. It's a real estate company. The whole movie, the founder, whatever. Be. Yeah, it's a great movie. Talks about how McDonald's like, you know, was whole, all built on the real estate and the franchise at all, the only underneath the real estate. So really it's a real estate company. Red Lobster is a same kind of deal. You gotta lease the land and that's how the company makes money, not from food sales and things like that. Yeah. So. But the key thing you hit on there is the amount of debt. Right. So the billion dollars in debt. And a lot of companies. A lot of companies, though, have tons of debt. So express was another one. Yep. You know, they're apparel brand, usually for younger, I think 2030. Right. There was another company route, 2021. So they're kind of grouped in the same thing. It's like that consumer discretionary teen shopping. But I mean, that's such a. You should know, that's such a risky business. I remember when I was younger going to like merry go round or what? You know, like these different chains to get certain clothes. But as soon as they're not in style, they went out of business chasing and, you know, chasing. A teen's desired address is gotta be hit or miss. And margins are thin. Margins are thin, wallet share inflation. I mean, you know, I would assume that the majority, maybe not all, but the majority of teens buying clothes comes out of their. Their wallet. Maybe they're some of their parents, but maybe some of them have. Do have jobs and they got to go buy their own stuff. Kids have jobs. Really? I don't know. I don't know. Not in this environment. Another type of company that's been going out of business is solar. And we've talked about that with, like, just investment had investment themes where wind and solar just are not ready for prime time use. Logically, technology, the amount of energy to create the energy is almost awash, or the technology is just too expensive. So solar, I'm sure, is very efficient. Cause you're just collecting sunlight. But when you start having to pay for that technology, it's not cheap. It's really the battery technology that's not there. So like solar, you need to store that technology after. So the converter. Exactly. So the conversion to the battery and the battery storing it, that's not there yet. So this is where you have the government coming in, incentivizing these sectors that aren't ready yet, that, you know, when they will be 1020 years down the road, free markets will be ready for that to come in. So you're seeing a lot of solar companies that took on a lot of debt, got a lot of investment come in, but now their demand's not there because free markets are safe. But it's also what, from my understanding, that's definitely one thing. They can't like all the things to the R and D to get. The technology is definitely expensive, but, like, then you have to find the consumer that wants to buy it, and it's not cheap. So then they therefore go and finance it. And when you have to finance at, you know, five to 10%, it's not cheap. I had somebody. Not to get you off topic here, I had somebody tell me that solar, mainly solar companies, and the way that it's kind of the economics and financial engineering works, it's almost like a money laundering scheme. I had someone tell me that because of the tax incentives. So, like, you literally get a new solar roof. You basically can get it for free because of the tax incentives. So all the companies are doing. Are using government funded money to go in there, and they're collecting checks from the government, not the free market. That's what we were doing with EV's, dude. Let's talk about that. So when you were getting 510 grand as a rebate, guess what? The EV's are five to $10,000 more. It was a bad idea to give the incentives for EV's because all the. All of the, you know, automakers just jacked up the rate. Well, you're seeing EV's now go bankrupt. Fisker just filed. Fisker was a good looking car, actually. Ocean was a good looking. It was a. It was suv. Yeah. And they're, like, sport. Like, there's sedan. I'll tell you what. I think the majority of EV's actually look really cool because the design, like, they. They don't have an engine. Right, right. Like, it's not as. You know, I want to say they're not as heavy, but they are. But, like, they can make them look really cool. Like the Porsche. EV looks phenomenal. Like, the best looking porsche they might have, in my opinion. Like, I. That's why it's always been boggling to me, like, how I don't think Tesla's are that good looking of a car, honestly. And they haven't really changed the design either. So the buyer of my. But that's probably a smart person, like, Elon is. I don't care what it looks like as long as it runs and it runs efficiently. And the technology, like, he's not thinking of, like, the other emotional side of it. Like, man, it's a sexy looking car. Or it's not at the end of the day, I think you're seeing a lot of now the turnover in electric vehicles. So Fisker is one of them. You have, like, lucid out there. You have Rivian, you have all these other ones that have so much debt out there. But the thing is about, like, rivian, you have Amazon backing them. You have, like, I think, lucid. You have like, this china, and you have also, like, the oil middle east, right? Like, the funds over there backing it. So you have still this money pouring into some EV areas. But, like, I think the majority of these small EV companies are going to be bankrupt in the end. Like, there's just not enough demand right now to keep them going. So that's one other area that we just hit on there, the electric vehicle side. Other thing that I've witnessed the past month, lumber liquidators, you saw it go bankrupt just like last week. They're ll flooring. So they have a ton of debt outstanding, and people aren't building houses as much anymore. You've seen home sales down a lot. Renovations are down a lot. You saw Home Depot. I mean, the home sales stuff is that, like, there's starting to become a backlog of new homes, right. That's crazy. Like, I can't wait to see how this really shakes out. But, I mean, you have no one selling their existing home, and then you got a bunch of new homes out there. Maybe they'll sell when interest rates come down. But I'm imagining these builders are going to take such a haircut to move a house, right. Because they're sitting on a high inventory, according to a lot of reports I'm reading. But, well, these new houses, too, a lot of these home builders are financing the houses through themselves. So I'll give the example of, my cousin just built a house in Columbus area, and the reason why they were able to get a little bit discounts on some things was because they went financing through their company. So basically, these companies are acting as the banks, right? So that's. That's how they buy down the rates. And they do all of. Well, that's a good thing, as long as people are able to pay back to them. The problem is what happens? You don't want to be the bank. Well, what happens if you're the bank and shit hits the fan? Yeah. That's the thing you want to pay attention to. That's. So if you're looking to invest in home builders, maybe you want to look for the ones that are not doing self finance. Correct? That's right. They're trying to get current revenues moving and not having the foresight of, oh, man, look what happened. There's a recession. People are losing their jobs. Oh. They can't make their mortgage payments. Oh, man, I'm. And I'm done. No one thinks about that. So at the end of the day, a lot of these bankruptcies, you know, obviously keeping up with trends and wallet share and in online marketing versus brick and mortar, those are all things. But at the end of the day, what I'm really seeing with all of this is the cost of borrowing money. Interest rates are starting to really squeeze margins on every level for every business. When you were borrowing rates at one, two, 3%, and now it's eight or above. That's a big problem. Huge. And that those little things are catching up. Yep. And then you have. I'll throw out one more just because my mom used to sell it. Avon. Right. Everyone knows the cosmetic brand Avon because when I was growing up, everyone's in. Their mother seemed to be, including my mother's used to sell it. So, you know, you have lawsuits, like, Avon's dealing with lawsuits. Avon parties, Tupperware parties. Yeah. Just think that the Mary Kay people of the world are probably salivating right. Now, but I think they have lawsuits that some of their cosmetic brand, like, cause cancer or whatever it be, there's some. Something there. So, like, then you have this high interest rate environment to these companies where it's hitting margins, but then you also have potential lawsuits. So it's like all these unknowns, like, whether it's lawsuits, interest rate, debt, hidden margins. Like, there's a bunch of unknowns out there for companies that a lot of companies didn't prepare for. So, again, hitting on your topic that you just brought up, everyone is trying to make money when times are good, but when times are bad, no one kind of prepares for the times bad. And the question is, are we entering into a bad period and how much, if we are entering into a bad period, how much of these fluff companies are going to be wiped out? Yeah. So, I mean, I think the rate of change is important to bring up. I don't think this is the end. I think this is somewhat of the beginning of a bigger kind of wipeout. The Federal Reserve, I told, I've spoken to them this before. The Federal Reserve was created for two reasons. To bail out things and to break things. And right now, they're breaking things. And essentially, it's doing what it was designed to do. They wanted to break things to cool off the labor market. They wanted to break things to cool the economy from inflation purposes. Right? So the two questions out there is how much are things going to break? And when things do break, what are they going to do to interest rates? You know, the base case is still a soft landing, so maybe we'll talk about that in a different podcast about, you know, what does a soft landing look like? What does a hard landing look like? What does a no landing look like? All right, well, again, thanks for listening to us. It's like all the implications going on with small businesses and their bankruptcies right now. What does it really mean? Why is it really happening? So hopefully, shed some light on that. And as always, if you have a topic or a question, you can always hit us up at info@swpconnect.com but other than that, have a great day and we'll see you in the next episode. 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