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Monitoring Tip |
Impact of Changing Markup on a Retail Store's
Net Orderly Liquidation Value -- NOLV
by Tom Scotti, Chief Operating Officer, Gordon Brothers Group - Appraisal & Valuation Division
When one is appraising assets, one must always be conscious of how the actual disposition process can impact the net proceeds from a sale, its Net Orderly Liquidation Value -- NOLV. Every asset class has its own particular conventions and methodologies, and the retail disposition market is no different.
A key feature of a retail disposition is that the sale process uses the company's stores as the selling platform, and goods are sold directly to the consumer. Consumers know what they pay for merchandise (the retail price), but not what the merchandise actually costs the retailer (the cost). The customer's buying behavior, as it relates to the merchandise, is measured continually through the net product margins realized by the retailer. To that end, as retail disposition agents quantify through their analysis what they are willing to bid for a liquidation, they think in terms of the consumer. To that end, they think in terms of retail pricing and a retail-oriented bid. In fact, more often than not, most agency agreements reference the retail value of the goods and bid a percentage of that retail value.
For instance, take a hypothetical example where the nominal value of the inventory is as follows:
| |
Cost |
Retail |
Markup percent |
| Inventory |
$1,000,000 |
$2,500,000 |
60 percent |
In analyzing the maintained margin of the inventory (sales net of discounts) and determining the expense structure of the stores and length of the sale, the disposition agent then determines that the bid should be $750,000 on that inventory. That bid of $750,000 is both 75 percent of the cost value as well as 30 percent of the retail value. In an agency agreement, the representation of the bid would most likely reference the "30 percent of retail."
This bidding convention is a potential exposure for all lenders who base their borrowing base upon the cost value of the inventory. Here is why.
Over time, due to any number of reasons including marketplace competition, increased sourcing costs and others, let's say that for that same amount of retail inventory, the cost of those goods is now higher:
| |
Cost |
Retail |
Markup percent |
| Inventory |
$1,050,000 |
$2,500,000 |
58 percent |
Assuming the discount patterns, sales trends and expense structure of the retailer are the same, the bid from an agent would most likely still be the 30 percent of retail; however, this $750,000 bid would now only be 71.4 percent of cost, a 3.6 percentage point decline from the prior analysis. While that decline may not sound like very much, loans today to retailers are often 90-95 percent of an appraisal, and sometimes even have a stretch piece putting the loan at appraised value. In these situations, a three point decline can have a dramatic impact on the liquidity and management of the credit.
Lenders to retailers should always understand the relationship between the cost and retail value of the inventory they are lending against. To the extent the markup on the goods changes, lenders need to understand the reasons for the change and dialogue with their appraiser as to its potential impact.
And that is the tip of the day.
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