We Worry Sears Will Sell Winners To Pay For Losers

| About: Sears Holdings (SHLD)

Department store Sears (NASDAQ:SHLD) continued its long decline during its third quarter, as evident from results. The company exceeded consensus revenue estimates, though revenue still fell 6% year-over-year to $8.9 billion. Earnings, adjusted for certain items, actually increased to a loss of $1.99, which was significantly better than consensus expectations.

Though results were better than expected, the company's deterioration continued during the quarter. Same-store sales growth was weak across the board, though we saw some signs of life from the Sears Domestic business. Same-store sales fell 1.6%, and management noted that net of consumer electronics, same-store sales would have increased. Appliances remain an area of strength due to the housing recovery, and management noted that apparel improved. Gross margins ticked up 10 basis points to 27%, but the segment still isn't profitable enough to cover SG&A expenses, which remain at 29.5% of sales. We see some decent upside in the domestic business if the company can capitalize on the housing recovery, and fight off some of the competition in the space.

K-Mart's comps were much worse, with same-store sales declining 4.8% and sales registering just a notch over $3 billion. Compared to other discounters like Target (NYSE:TGT) and Wal-Mart (NYSE:WMT), K-Mart's numbers look particularly bad. Both stores are dealing with the same headwinds-weak consumer electronics and shifts to generic drugs-but Target and Wal-Mart offer superior shopping experiences and product mixes, in our view. There's little reason for K-Mart to exist when both competitors have done retail better. Gross margins were just 21.8%, down 110 basis points from the prior year, while SG&A totaled 26% of revenue. We expect weakness at K-Mart to persist over the long-term.

Sears Canada, once a bright spot of the struggling retailer, also posted poor results during the third quarter, with same-store sales declining 5.7% year-over-year. Management cited weakness from every single division, except mattresses and appliances, as the main culprits of the decline, and it appears the segment has lost touch with its consumers. The company recently spun off 45% of the company to its existing shareholders, but it still remains a possible source of strength for Sears Holdings, assuming the Canadian economy recovers. Gross margins for the segment increased 220 basis points year-over-year to 29%, and its profitability continues to outpace the rest of the company. Such a large same-store sales decline is never positive, but at least the segment has better margins (for now).

Overall, we thought Sears' third quarter was weak, though not surprising. The company continues to monetize its assets via spinoffs and divestitures, and it remains bullish about opportunities with respect to its real estate portfolio. Chairman Eddie Lampert's initial thesis heavily involved monetizing the firm's real estate portfolio, though we worry the company might sell its winners to pay for its losers (monetizing valuable assets to keep bleeding money via the declining assets). JC Penney's (NYSE:JCP) alienation of core customers may help Sears in the near term, but we aren't optimistic about the company's long-term odds for success. Inventories are down substantially year-over-year, which is positive, in our view. Near-term liquidity is also stable, and the company won't "generate cash for the sake of generating cash [from asset sales]." We're not at all interested in the company, nor do we see operations improving.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.