The Downward Spiral Of Sears Canada

| About: Sears Canada (SRSC)

Summary

Sears Canada is in a similar situation to Sears in the United States. It has continually declining sales, and is attempting to cut costs sharply to reduce losses.

The late 2015 termination of its credit card agreement with JPMorgan Chase is a heavy blow that could impact its gross margins by over 3%.

Sears Canada does have some time, with close to four years of cash remaining if it sells its remaining real estate.

However, in recent years, the company's operational losses have increased despite significant cost cutting.

Unless it is able to reverse its sales decline, Sears Canada's future looks quite bleak.

Much like Sears (NASDAQ:SHLD) in the United States, Sears Canada (NASDAQ:SRSC) is enduring substantial retail losses and is slashing costs and selling assets in order to bolster its balance sheet. Sears Canada's balance sheet looks OK right now, since it does have a decent cash position (with $350 million CAD, or $269 million USD, at the end of Q1 2016), with another $60 million CAD ($46 million USD) due from previously announced real estate transactions. Sears Canada also has no long-term debt (although it does have substantial retirement benefit liabilities) and the potential to monetize its remaining (dwindling) real estate portfolio, so it probably has a few years of runway remaining.

However, as long as same-store sales continue to fall, it is unlikely that cost cutting can halt Sears Canada's cash burn. Same-store sales have been in a tailspin for years, and it is difficult to envision a successful turnaround occurring after such a long period of decay. As well, the various sale/leaseback transactions are bolstering the company's cash position, but at the cost of increasing expenses and putting operational breakeven even further away. Sears Canada also has taken a major hit from the termination of its credit card marketing agreement, which appears to have negatively affected gross margins by 3%.

With a market capitalization of under $400 million CAD ($308 million USD), Sears Canada is essentially valued at less than its cash (including the amounts it is owed from real estate transactions). But due to its continuing cash burn, I still don't think it is a bargain. The company may be able to survive for a few more years, but its long-term future appears dim.

Sears Canada primarily trades under the ticker symbol SCC on the Toronto Stock Exchange. I've also converted Canadian dollar amounts to US dollars in this article at an exchange rate of $1.30 CAD = $1.00 USD.

Credit Card Program Termination

The company's credit card program ended in November 2015, when JPMorgan Chase Bank terminated the credit card marketing and servicing agreement. Sears Canada received a $174 million CAD ($134 million USD) payment as a result of that termination and the sale of the credit card portfolio to Scotiabank (NYSE:BNS). This helped increase the company's cash position, but left it without a credit card partner, since Scotiabank bought the credit card portfolio, which did not continue the Sears Canada credit card program. Store credit cards are a fairly major source of income for department stores, so this is a significant blow to Sears Canada in the long run. It appears the company's credit card income was equal to 3.5% of revenue in Q1 2015, and the loss of credit card income has resulted in lower gross margins. Sears Canada has not been able to find a new credit card partner to replace JPMorgan Chase Bank.

Operational Results Continue To Be Poor

Sears Canada recorded adjusted EBITDA of negative $160.5 million CAD ($123.5 million USD) in 2015, worse than 2014's negative $122.4 million CAD ($94.2 million USD) adjusted EBITDA. After including capital expenditures, it is burning around $210 million CAD ($162 million USD) per year at 2015's sales, expense and gross margin level.

In Q1 2016, the company recorded adjusted EBITDA of negative $75.4 million CAD ($58 million USD), which was $24.9 million CAD ($19.2 million USD) worse than that in Q1 2015. Sears Canada mentioned that the termination of the credit card marketing and servicing agreement reduced adjusted EBITDA by $24.9 million CAD ($19.2 million USD), indicating the large hit caused by the termination. Without the credit card agreement termination, the adjusted EBITDA result would have been the same as Q1 2015. However, that just shows what caused Sears Canada's results to worsen, but it can't solve that issue without a new credit card partner. As Sears has been unable to find a new partner in the 20 months since JPMorgan Chase gave notice that it was terminating its agreement, its chances of getting a new partner in the future appear slim.

Sears Canada is planning on cutting costs in 2016 by $141 million CAD ($108 million USD). Since some of that cost reduction comes from closing stores, the improvement to the company's bottom line will be less, though, so it may still have trouble reducing operational cash burn below 2015 levels without sales improvements.

Real Estate Assets Dwindling

As of April 2016, Sears Canada owned nine full-line department stores, two Sears Home stores and two outlet stores. It also appears to have four owned warehouse facilities remaining. Due to its many real estate transactions (selling stores and doing sale/leaseback transactions for other warehouse facilities) during the past few years, the company has monetized the majority of its real estate. Desjardins Securities does estimate that Sears Canada has around $350 million CAD ($269 million USD) remaining in real estate assets, although there is now a glut of vacant retail space in the country, as Target's (NYSE:TGT) exit altered the Canadian retail real estate market.

Sears Canada appears to have around two years of cash on hand if its cash burn is around 2015 levels. Monetizing the remaining real estate may get it nearly another two years of time. That's basically how long Sears Canada has to reach operational breakeven and halt its decline in same-store sales without completely running out of cash. The company also has a $300 million CAD ($231 million USD) credit facility, but that may be reduced as Sears shrinks.

Conclusion

Sears Canada is fighting an uphill battle to stay alive in the long run. Its operational results have been deteriorating, and same-store sales have been continuing to decline as well. It has been buying time by selling its real estate, and still does have some real estate left, but will run out of money by the end of the decade if its operational performance doesn't improve from 2015 levels. A continuing decline in operational performance may cause the company to run out of money sooner. Sears Canada is currently valued at less than its cash position, but I don't think it is a good value, since its cash position and real estate value appear likely to be swallowed up by continued retail losses.

Author's Note: If you thought this article was interesting, please scroll to the top of the article and click on "Follow" next to Elephant Analytics. Thanks for reading!

Disclosure: I/we 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.