Sears: Shuffling The Deck Chairs On The Titanic

| About: Sears Holdings (SHLD)

Summary

Sears is selling paint again after exiting the market in 2012.

Google search information indicates that there is some interest in buying paint at Sears.

However the potential sales volumes appear relatively small ($80 million to $100 million) and would not make a difference to Sears' situation given the pace of its decline.

While Sears still has a market capitalisation of over $1.4 billion, its equity appears essentially useless in terms of raising additional funds.

More asset sales and/or debt is expected to be needed for Sears to build inventory for the 2017 holiday season.

Sears Holdings (NASDAQ:SHLD) made an announcement that it was going to sell paint again after exiting that market four years ago. Search data indicates that a fair number of people still search for "Sears paint," with search volumes only down by approximately one-third since Sears exited paints. However, despite paint sales potentially being incrementally beneficial to Sears, the overall effect on Sears' future is not much better than shuffling the chairs on the Titanic.

Effect Of Paint Sales

Wal-Mart had estimated sales of 22 million gallons of paint per year back in 2010. Google search volumes for "Wal-Mart paint" were approximately 3.3x greater than "Sears paint" at the time, so if search volumes correlate with actual sales, Sears would have sold approximately 6.6 million gallons of paint in 2010.

There are actually still a decent amount of searches done for "Sears paint" indicating that consumers may be interested in purchasing paint from Sears when it offers it again. With Sears' reduced store count and lower traffic/sales levels now, 4 million gallons of paint per year would probably be at the high end of Sears' paint sales potential though.

Assuming an average of $20 to $25 per gallon of paint would put the potential for Sears' paint sales at $80 million to $100 million per year. While this would be beneficial to Sears, it doesn't make much of an impact on its overall results. Even if there was no cannibalization of other sales (to make room for the paint section), the paint sales would only improve Sears Holdings' comps by +0.3% to +0.4%. This is equivalent to one month's sales decline given Sears' -5.2% comparable store sales decline in Q2 2016.

It also may take some time for Sears to reach that level of paint sales after reintroducing its paints. As well, after factoring in the cost of staff to deal with mixing the paint and other duties, the effect on EBITDA is likely going to be minimal. The $100 million in sales may translate into $10 million EBITDA or less, which is a drop in the bucket for a company that has been burning over $1.5 billion per year.

Ownership Of Debt And Equity

With the proposed $300 million loan, ESL/Eddie Lampert will have approximately $973 million in Sears debt. Fairholme holds $417 million in Sears debt and potentially more if Sears decides to solicit the additional $200 million in debt mentioned in the ESL proposal.

$ Million

ESL/Lampert

Fairholme

Unsecured Commercial Paper

$100

$0

Secured Loan Facility

$216

$0

2016 Secured Term Loan

$150

$0

Senior Secured Notes

$11

$46

Subsidiary Notes

$3

$14

Senior Unsecured Notes

$193

$357

New Junior Lien Debt

$300

??

Total Debt

$973

$417

Click to enlarge

With Sears trading at $13.49 per share, Lampert/ESL owns approximately $717 million in Sears common stock, while Fairholme owns $375 million. Thus, Lampert/ESL and Fairholme now essentially own more debt than equity in Sears.

This trend is likely to continue in my opinion as Sears will likely either issues more debt or asset sales to build enough inventory for the 2017 holiday season.

Despite the equity still trading for some value, it appears to have minimal value to Sears in terms of its ability to raise additional cash. An equity offering to outside investors at this point would result in a major increase in the shares available for trade and would probably cause Sears' stock to collapse. A rights offering for equity wouldn't work since it doesn't appear that Lampert/ESL and Fairholme want to put significantly more money into the equity.

Conclusion

While the reintroduction of paint sales should be modestly beneficial to Sears, its situation is far beyond the point where small moves will make any difference to its future. If Sears was stable and near breakeven cash flow, adding $10 million EBITDA from each of various small moves could help it. When comps are continuously falling by large amounts and cash burn (without asset sales) exceeds $1.5 billion per year, then $10 million (or even $20/$30 million) represents a rounding error to Sears' financials.

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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.