Sears Holdings: No More Kmart?

| About: Sears Holdings (SHLD)

Summary

There may be 204 Kmart store closures in FY 2016 between all the various store closure announcements and the stores that were closed early in 2016.

This represents 22% of the store base from the start of the year, while 44% of Kmart stores would have closed between January 2012 and January 2017.

The 204 Kmart store closures may add $100 million as a one-time effect to Sears's cash flow from inventory reduction, partially offset by store closing costs.

Annual cash flow could improve by around $70 million due to the closure of unprofitable stores, but it doesn't make much of a difference to Sears's $1.5+ billion cash burn.

Sears Holdings (NASDAQ:SHLD) continues to close many stores as its business struggles. With the news of the latest Kmart store closures, it appears that over 200 Kmart stores will close during FY 2016, or approximately 22% of the store base from the start of the fiscal year. Thus, it would not be entirely surprising to see Kmart disappear entirely within a few years. The rate of closures for Sears-branded stores isn't as high, so Sears may maintain a physical presence for a while longer.

Diminishing Kmart Store Base

As of January 30, 2016, there were 941 Kmart stores remaining. During Q1 2016, Sears Holdings mentioned that it had closed 45 Kmart stores and also had made the decision to close an additional 93 Kmart stores. Sears Holdings made the decision to close another two Kmart stores in Q2 2016, and is closing at least an additional 64 Kmart stores now. This puts the projected number of Kmart stores remaining as of January 30, 2017 at 737 stores.

That means approximately 44% of the 1,305 Kmart stores (as of January 2012) will have been closed over the five years since that date.

Jan 2012

Feb 2013

Feb 2014

Jan 2015

Jan 2016

Jan 2017

Kmart

1305

1221

1152

979

941

737

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Effect On Cash Flow

Closing 204 Kmart stores may cost Sears around $200 million in various store closing costs, such as markdowns, lease termination fees and severance. However, it would also allow Sears to reduce its level of inventory, which would benefit cash flow. The inventory reduction could be over $400 million, leading to a net cash flow improvement of around $300 million for the inventory reduction after factoring out merchandise payables. That would appear to cancel out the store closing costs and result in a $100 million net benefit to Sears's cash flow.

As well, Kmart has been recording significant levels of negative EBITDA, with adjusted EBITDA at negative $273 million in 2015. This had improved slightly (by around 11%) during the first half of 2016, but Kmart's EBITDA still remains significantly negative. Closing the 204 stores may improve adjusted EBITDA by around $60 million and reduce capital expenditures by $10 million.

In effect, closing 204 Kmart stores during 2016 could result in a near-term benefit of around $100 million to Sears Holdings as well as improving annual cash flow by around $70 million. However, with Sears Holdings potentially burning over $1.5 billion per year without asset sales, the cash flow improvements from closing 204 Kmart stores doesn't make much difference to Sears Holdings's overall picture.

Sears Holdings may also be able to sell the real estate for its closed Kmart stores. However, it only owned 97 Kmart stores at the beginning of 2016, and the company has been generally paying to end leases of its leased stores rather than having the leases bought out by landlords, so I don't think the real estate value of the closed Kmart stores will amount to much either.

Sears Stores

As of January 30, 2016, there were 705 Sears stores (including 697 Full-line Sears stores) remaining. The company closed five Sears stores in Q1 2016 and made the decision to close an additional 24 stores during that quarter. It also made the decision to close an additional two stores during Q2 2016. There have also been several subsequent articles about Sears store closures in Bartlesville, Erie and Eden Prairie, and I am not sure if any of those have been included in the previous store closure numbers.

If those are newly decided store closures (not decided in Q2 2016 or earlier), then the company may end up with approximately 671 Sears stores in 2017, down 23% from five years ago.

Jan 2012

Feb 2013

Feb 2014

Jan 2015

Jan 2016

Jan 2017

Sears

867

798

778

717

705

671

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Sears Domestic has been producing much lower adjusted EBITDA than Kmart (negative $563 million in 2016 compared to Kmart's negative $273 million). However, I think that most/all of the corporate costs get allocated to Sears Domestic, so its store-level EBITDA would be better than Kmart's. As well, fewer Sears Domestic stores are leased (around 57% for Sears versus 90% for Kmart). The combination of higher store-level EBITDA and fewer expiring leases probably explains the lower store closure rate.

Conclusion

Kmart is being hit particularly hard by store closures, with approximately 22% of its stores closing during this fiscal year, and may not last beyond the end of the decade given the pace of closures. The store closures should give Sears a bit of a cash flow boost as it converts inventory to cash, as well as help Sears's annual cash flow by closing unprofitable stores. However, despite the large rate of store closures, it will be hard to significantly reduce the company's cash burn as long as comparable store sales continue to decline. Even closing 22% of Kmart's store base may only reduce Sears's current annual cash burn by under 5%.

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