Sears Holdings: Cost Burdens Weigh On The Stock

Sep. 1.14 | About: Sears Holdings (SHLD)

Summary

Another quarter, another disappointment from Sears Holdings.

Cost pressures drove losses higher.

Some silver linings existed in the details of the Q2 numbers that provide opportunities for the future.

Whether good or not, Sears Holdings (NASDAQ:SHLD) finally completed a quarter where revenue wasn't the real issue at the retailer. Sure the company saw a substantial decline in sales, but the majority of that decline came from shuttering stores and spinning off Lands' End (NASDAQ:LE). Most of the headlines from the media focused on the declining revenue trends and not the real issue which is duplicate costs for the online and promotional strategies to transform the retailer.

The stock rebound following the initial plunge was likely due to the realization that some of the numbers under the surface were actually somewhat solid. Comp sales at full-line domestic Sears stores were actually positive and online sales grew 18% over the prior year Q2. Though the adjusted EBITDA loss was absurd and not acceptable going forward, the focus is now on whether Sears can strip out costs while stabilizing the revenue base at existing levels.

Q214 Results

The Q2 numbers were mostly hideous especially reviewing the profit related one. Revenues dropped, adjusted EBITDA plunged, and gross margins fell, yet some encouraging numbers were below the surface.

  • Adjusted EBITDA fell to $(313) million, down from $(78) in the prior year second quarter.
  • Revenue fell to $8 billion, compared to $8.9 billion last year.
  • Sears full-line stores had comp store sales growth of 0.1% for Q2, while Kmart declined 1.7% during the quarter.
  • Online and multi-channel sales grew 18% over the prior year Q2.

As the slide below highlights, the majority of the revenue decline was based on the spin-off of Lands' End and the closure of stores.

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Source: SHLD Q214 presentation

With comp sales at the domestic stores only contributing $47 million of the revenue declines, Sears Holdings is finally seeing some stability in the revenue base.

Cost Reductions Too Slow

So if revenue isn't really the problem creating the massive loss for Sears, then clearly the substantial decrease in EBITDA had to do with costs. According to the company, the Shop Your Way promotions are costing the company double with the need to provide promotional discounts to all customers and the Shop Your Way points to members.

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Source: SHLD Q214 presentation

Again, the large decline in gross margin is partially due to the store closures and Lands' End, but at least $200 million is due to the promotions listed above. The real question is whether Sears Holdings can maintain the revenue base without the double promotional discounts to members. Management suggests the promotional discounts will go away eventually with a focus on the points line only.

Potential EBITDA Improvements

Sears Holdings still thinks it can dramatically improve EBITDA margins via several initiatives, including cost reductions, optimizing stores, and productivity improvements. Analysts don't agree with forecasts for losses per share approaching $10 in both 2014 and 2015. Investors can review the below initiatives and make their own decision.

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Source: SHLD Q214 presentation

Conclusion

With the stock holding up relatively well since the disappointing Q214, it suggests that a decent amount of investors still believe in the story of Sears Holdings. The company still has vast assets, including the real estate that far exceed the current market cap of $3.7 billion. The real question is whether the struggling retailer can trim the losses from operations so that each day it opens the stores they don't eat away at the asset base. Unfortunately, the stock will continue to face pressure with the continual process of closing stores and spinning off assets reducing the revenue base. Investors love growing numbers after all.

At the end of the day, Sears Holdings still has 1,900 stores and 200 million square feet with stores in some of the most desirable domestic malls. It is virtually impossible to invest in Sears based on any multiple. Either you believe in the transition and the assets or you don't. Its really that simple. The opinion remains that Sears Holdings is a cheap stock misunderstood by the market.

Disclosure: The author is long SHLD.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.