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The Bankruptcy of W.T. Grant: A Failure in Planning

W.T. Grant was the largest and one of the most successful department store chains in the United States with 1,200 stores, 83,000 employees, and $1.8 billion of sales. Yet in 1975 the company filed for bankruptcy, in what Business Week termed “the most significant bankruptcy in U.S. history.”

The seeds of Grant`s difficulties were sown in the mid-1960s when the company foresaw a shift in shopping habits from inner-city areas to out-of-town centers. The company decided to embark on a rapid expansion policy that involved opening up new stores in suburban areas. In addition to making a substantial investment in new buildings, the company needed to ensure that the new stores were stocked with merchandise and it encouraged customers by extending credit more freely. As a result, the company`s investment in inventories and receivables more than doubled between 1967 and 1974.

W.T. Grant`s expansion plan led to impressive growth. Sales grew from $900 million in 1967 to $1.8 billion in 1974. For a while profits also boomed, growing from $63 million in 1967 to a peak of $90 million in 1970. Shareholders were delighted. By 1971 the share price had reached a high of $71, up from $20 in 1967.

To achieve the growth in sales, W.T. Grant needed to invest a total of $650 million in fixed assets, inventories, and receivables. However, it takes time for new stores to reach full profitability, so while profits initially increased, the return on capital fell. At the same time, the company decided to increase its dividends in line with earnings. This meant that the bulk of the money to finance the new investment had to be raised from the capital market. W.T. Grant was reluctant to sell more shares and chose instead to raise the money by issuing more than $400 million of new debt.

By 1974 Grant`s debt-equity ratio had reached 1.8. This figure was high, but not alarmingly so. The problem was that rapid expansion combined with recession had begun to eat into profits. Almost all the operating cash flows in 1974 were used to service the company`s debt. Yet the company insisted on maintaining the dividend on its common stock. Effectively, it was borrowing to pay the dividend. By the next year, W.T. Grant could no longer service its mountain of debt and had to seek postponement of payments on a $600 million bank loan.

W.T. Grant`s failure was partly a failure of financial planning. It did not recognize and plan for the huge cash drain involved in its expansion strategy.



Category: Cash flows




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