The Window For Sears Holdings Seems To Be Closing Fast

By Stephen D. Simpson, CFA | May 23, 2012 AAA

There's no such thing as an essential retailer. Ask anybody younger than 35 about Montgomery Ward or Service Merchandise and you're likely to get a blank look; the same will be true of names like Mervyn's and Circuit City before too much longer. Although Eddie Lampert's team is working hard to fix what ails Sears Holdings (Nasdaq:SHLD), it is increasingly looking like an uphill battle for a company that is being out-done on multiple retailing fronts.

Stronger Q1 Results Came off a Weak Base
The first quarter results at Sears Holdings may look like a sign that the company has stopped the bleeding, but I would be careful about jumping to that conclusion.

Revenue declined 3% this quarter, as total retail comps declined 1.3%. Comps at Sears dropped 1%, while Kmart comparisons fell 1.6%. Gross margin picked up a point from last year, as Kmart gross margin improved 60bp and Sears improved 140bp.

SEE: Analyzing Operating Margins

Asset sales, closing costs and other miscellaneous items do interfere with the calculation of comparable operating income numbers, though the company does seem to have reversed a year-ago loss. Looking instead at adjusted EBITDA (a company-calculated measurement), Sears Holdings grew better than 200% from the year-ago period, though falling 44% from the holiday-heavy prior quarter.

Comps Might Not Be as They Seem
Sears Holdings reported that Sears' comps were boosted by double-digit increases in the apparel and footwear categories. Given the weak performances at J.C. Penney (NYSE:JCP) and Kohl's (NYSE:KSS) this quarter, that had to have helped Sears (even though Walmart (NYSE:WMT) posted a solid mid-single-digit improvement).

The flip-side to this is that it looks like comps in electronics, appliances and home improvement were not nearly so strong. Given the recent report from Home Depot (NYSE:HD), that's a troubling sign. Retailer data suggests that Sears' proprietary brands may be picking up a little bit of share, but it looks like the company continues to struggle against a wide range of comps like Best Buy (NYSE:BBY), Home Depot, Lowe's (NYSE:LOW), Target (NYSE:TGT) and Walmart.

SEE: The 4 R's Of Investing In Retail

Selling What's Left to Sell
Management continues to move ahead with asset disposals that raise much-needed liquidity. The company has moved ahead with rights offerings for Sears Hometown and Sears Hardware, and more could be on the way. Given how often management has talked about Land's End and Sears Canada as "successful stand-alone businesses," it hardly seems speculative to suggest that the company will ultimately spin off these assets.

Too Little, Too Late
Sears Holdings management should be lauded for the operating improvements they've made. The company has wisely chosen to be "platform neutral" when it comes to the customer's desired shopping experience (in-store, online or in-store pick-up), but that doesn't mean they can compete effectively with Amazon (Nasdaq:AMZN). Likewise, the company has a quality membership rewards program, but can that really drive a traffic recovery?

Kmart's roots may run deeper than those of Walmart or Target, but Kmart is just another discount retailer today. Likewise with Sears Holdings - what does this company offer that Best Buy, Home Depot, or Walmart cannot?

At the same time, the company is trying to save costs by closing stores, cutting costs and trimming inventory. More often than not, that usually points towards worse customer shopping experiences and shabbier-looking stores relative to the competition - not things that typically drive big traffic improvements.

SEE: Is Online Shopping Killing Brick-And-Mortar?

The Bottom Line
The ongoing struggles of Sears Holdings have largely quashed the "next Buffett" conversations around Sears Holdings chairman Eddie Lampert, and Sears Holdings may be well on its way to a place in articles highlighting the risks of following famous investors with your own money.

I'm not going to rule out the possibility that Sears Holdings can turn itself around, but I would observe that most successful retail turnarounds are with smaller companies like Pier 1 (NYSE:PIR). The assets and cash flow of Sears Holdings will buy it some more time, but absent real improvements in same-store sales and margins, I see no reason to take the leap of faith that these shares demand today.

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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