Sears Holdings Might Be An Attractive Short Prospect

Aug.21.14 | About: Sears Holdings (SHLD)


Shares of Sears Holdings fell over 7% on Aug. 21 after reporting revenue and earnings that missed analyst forecasts.

In all fairness, some of this decline was due to Lands' End and Sears Canada, but even after removing these from the picture, the retailer's situation doesn't look pretty.

Its increase in cash and cash equivalents would bode well if it weren't for the fact that all of this increase and more is one-time in nature.

Combine the above issues with the huge and expanding debt load on Sears' balance sheet and the company looks like it might make for an attractive short prospect.

Aug. 21 was not a great day to own shares of Sears Holdings (NASDAQ:SHLD). After the retailer reported revenue and earnings for the second quarter of its 2014 fiscal year that missed expectations, the shares of the once high-flying company fell over 7%, nearing its 52-week low. In light of this development, should investors consider a closer look at Sears as a contrarian play, or are the fundamentals signaling worse times to come?

Sears easily missed on both the top and bottom lines

For the quarter, Sears reported revenue of $8.01 billion. In addition to representing a 10% drop from the $8.87 billion management reported the same quarter a year earlier, the retailer's top line missed the $8.13 billion analysts anticipated. Although comparable store sales in its Kmart operations fell 1.7% (partially offset by a 0.1% improvement in Sears' Full-Line stores), the biggest contributor to the company's drop in sales was the 8% drop in the number of stores in operation, which fell from 2,497 locations to 2,302.

Aside from these factors, there were other noteworthy issues at play that pushed Sears' revenue down. Because Sears divested itself of its Lands' End (NASDAQ:LE) subsidiary through means of an IPO, it no longer receives revenue from that business. This alone accounted for a $330 million decline in the company's sales for the quarter. Another contributor to its decline was the drop in revenue reported by Sears Canada (SEARF), which accounted for $140 million of Sears' falling top line. Due to a 6.8% decline in comparable store sales, combined with a reduction in store count that had a $35 million negative impact on its top line, poor results in its Home Services business, and foreign currency fluctuations, Sears Canada was hit hard during the quarter.

Earnings Overview
Last Year's Forecasted Actual
Revenue (billions) $8.87 $8.13 $8.01
Earnings per Share -$5.39 N/A -$1.83
Earnings per Share (adj.) -$1.56 -$2.63 -$2.87
Click to enlarge

From a profitability perspective, the company's performance was even worse. For the quarter, management reported a loss per share of $5.39. This was significantly worse than the $1.83 loss per share seen in last year's quarter and easily missed the $2.63 loss analysts hoped to see. If, however, investors adjust for certain one-time expenses like impairment charges, store closures, and income tax adjustments, Sears' loss per share would have come out to $2.87. This isn't much worse than the $2.63 shortfall Mr. Market expected to see but is still larger than the $1.56 adjusted loss seen a year earlier.

According to Sears' press release, this widening of losses was driven, in part, by its lower revenue but can also be chalked up to an increase in its cost structure. For the quarter, management saw the retailer's cost of goods sold hit 78.3% of sales. This was noticeably worse than the 75.4% of sales cost of goods sold made up in last year's quarter. Also on the rise was Sears' selling, general and administrative expenses, which inched up from 25.8% of sales to 26.4%.

Things might be worse than they appear

There's no denying that Sears had a pretty poor quarter. Even after accounting for one-time events, the business lost $305.1 million, nearly double the $165.5 million management booked a year earlier. From here, it looks like things couldn't get worse; they can.

For the quarter, Sears reported having cash and cash equivalents of $829 million, up 24% from the $671 million seen a year earlier. Although this is, generally speaking, good news, the company's statement of cash flows reveals that the source of this increase in cash isn't recurring. According to its quarterly report, Sears saw a $515 million windfall from its Lands' End divestiture that it classified under its cash flows from financing activities category.

Adjusted Cash and Cash Equivalents
($ in millions) 2Q 2014 2Q 2013 Change
Cash Balance $829 $671 +23.5%
Less: Lands' End Transaction $515
Adjusted Cash Balance $314 $671 -53.2%
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This was, however, partially offset by a $32 million increase in the retailer's cash flows from operations and a $132 million decline in cash flows from investing activities as an increase in the purchase of property and equipment and lower proceeds from the sale of certain assets negatively impacted its cash flows. Excluding the amount Sears attributes to Lands' End, its cash and cash equivalents would be at $314 million, ceteris paribus.

Change in Long-Term Debt
($ in billions) 2Q 2014 2Q 2013 Change
Long-Term Debt + Cap Leases $2.82 $1.91 +47.3%
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When you look at Sears' cash situation and then add to this the fact that its long-term debt and capitalized lease obligations ballooned by 47% to $2.82 billion from the $1.91 billion seen in last year's quarter, the picture doesn't look too nice. This equates to a debt/equity ratio of 3.06, which is far greater than the 0.68 ratio seen this time last year.


Based on the data provided, Sears is in a pretty rough spot. During the quarter, sales were hit harder than expected and profits were hit even harder than that. Add to this the fact that the company's long-term debt is on the rise while equity is falling and that its increase in cash on hand is the by-product of an asset divestiture and it's not too hard to tell that the situation looks bad. In the end, Sears may succeed in turning itself around, but given its track record and the fact that this record is worsening and it's possible that the business could make for an amazing short prospect.

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