Softer And Softer Side Of Sears Holdings

It looks like Edward Lampert has lost another round in his great experiment with retail. Neither of the two major brands that comprise Sears Holdings(SHLD) were in good shape when he purchased them. He famously purchased Kmart in

bankruptcy, buying debt for pennies on the dollar and emerging from bankruptcy with a controlling stake(despite the small distraction of being kidnapped amid negotiations). We’d previously posted that Sears strategy of drift needed to end and about some signs we saw of a new strategy taking hold under new CEO Lou D’Ambrosio.  Today, Sears announced dismal holiday sales and the closing of 3% of its full-line stores.

Despite gimmicks like extended pre-Christmas hours, the company’s same-store sales were down 5.2%(4.4% at Kmart and 6% at Sears). Much of the decline came from sales of consumer electronics, which were weak in both chains. One bright spot was that Land’s End sales were up year over year.  The company now projects that Adjusted EBITDA for the 4th quarter, will be less than half of last year’s dismal $933 million.  Actual earnings will be far worse, driven by a non-cash charge of between $1.6 and $2.4 billion related to change in valuation allowance for deferred tax assets(you need to make money to use deferred tax assets), and impairment of goodwill.

Most significantly, the company will be closing 100-120 full line stores. The specific stores have not been announced, but the closings will generate $140 to $170 million in cash as inventory is sold, before any cash received from monetizing the underlying real estate. The company will reduce peak inventory on top of that by $300 million and reduce fixed costs by $100 to $200 million. In total the company expects that the actions will reduce peak borrowing next year by $300 to $350 million.

Mr.D’Ambrosio described a change in the company’s strategy  regarding marginally performing stores:

In addition to the specific store closures listed above, we will carefully evaluate store performance going forward and act opportunistically to recognize value from poor performing stores as circumstances allow.  While our past practice has been to keep marginally performing stores open while we worked to improve their performance, we no longer believe that to be the appropriate action in this environment.  We intend to accentuate our focus and resources to our better performing stores with the goal of converting their customer experience into a world-class integrated retail experience.

Hopefully, it’s not too little, too late for Sears, as Jeanine Poggi at TheStreet.com reports that suppliers will pull back on extending credit to the retailer.  Sears itself has finally become concerned with liquidity, as the company notes that no shares were repurchased this quarter, ending quarter after quarter of plowing cash flow into aggressive buybacks. Interestingly, or, perhaps ominously, the company did not comment on either its online business or early results of licensing its brands for sale at other retailers.

We hope that these closings mark the first step in an aggressive pruning of money-losing operations. If online, brand licensing, and franchises can continue to grow at higher margins, and hidden gems like home services can be more fully exploited, we think the company can still return meaningful profits for shareholders.  The company may want to pursue additional spinoffs(perhaps of Land’s End or Craftsman) following the Orchard Supply spinoff. In any event, as long as the company can control the liquidation of its assets over a long period of time, shareholders will benefit, but the company is indeed walking a fine line and may soon cross into the point of no return.

At the open this morning, Sears is trading down 19% to $37

Disclosure: The author owns shares in SHLD

Related articles

• Sears to close 100 to 120 Kmart, Sears stores (theglobeandmail.com)
• Sears and Kmart to axe 120 stores (bbc.co.uk)
• Sears Holdings Is Closing Up To 3% Of Its Kmart And Sears Stores (SHLD) (businessinsider.com)
• Sears to Close Up to 120 Stores (thestreet.com)
• Sears: Ebitda seen down; to shut up to 120 stores (marketwatch.com)