Sears Remains a Compelling Short

Sears Holdings (SHLD), the fourth largest broadline retailer in the US, recently reported a net loss of $56 million, or $0.43 loss per share in Q1 2008 versus net income of $223 million in Q1 of 2007. Total US same-store sales declined 8.6%.

Sears attributed this decline to several reasons: 1. Increasing competition. 2. Weakness in the general economy and housing market. 3. Increased costs in consumer staples such as food and gas. Interim CEO Bruce Johnson said, "Our first quarter results reflect the difficult economic environment and intense competition for consumer business." Following this corporate announcement, a string of business news and media reported exactly what Sears announced, that increased competition and the economy are the major reasons behind Sears' problem.

However, the fact is that the reports by the company and business media sounded overly optimistic. Indeed, the situation at Sears is much worse than it appears. If it really was increased competition and economic downturn causing Sears' loss, then other big-box retailers certainly should also have been feeling the heat. Yet, companies like Costco (COST), Big Lots (BIG) and Wal-Mart (WMT) reported better-than-expected earnings in their most recent quarters.

Sears' struggles cannot be fully attributed to the economy, a large portion of the decline is due to what I would call its faltering business model – the way the company is structured and how it operates as a retailer:

• Since the 2005 merger of Kmart and Sears, the company continues to operate the two brands separately. In addition, although, Sears has made positive mix changes at Kmart to better differentiate the brand from its competitors, the company has not executed the strategy to leverage Kmart's off-mall locations very successfully.
• Sears' merchandising categories are not attracting consumers. Consumers are rushing to buy necessities like food and gas, overlooking clothes, home appliances and lawn & garden accessories. Sears' strategy to focus on the latter categories has pushed the company to promote and markdown more often in an effort to dispose excess inventory.
• The company does not have any real competitive advantage or strategic direction. Since the 2005 merger, Sears has gone through a series of senior-level management shakeups and frequent changes in retail strategies – not great when you are a $50 Billion company operating thousands of domestic stores under separate brands.

Sears is not the same company as it was several years ago. The decline in the past year is not due to economic and competitive concerns; rather the company's business model is flawed. Too many wall-street analysts have pumped the company's stock too high – the decline is simply reflecting the reality of the company's situation. The road ahead will be tough.

Disclosure: Short

Comments

[GerrySullivan]

Sears and Kmart were 2 weak retailers when the merged. Merging 2 sick competitors hardly ever makes the combination a winner. Remember Penn Central?

What was the investment theme? I thought it was the value of the real estate. Did anyone really think that these 2 former greats would merge and regain their lost glory?

In the 1950s Sears was the world's largest retailer, having taken the
top spot from Woolworth. By the early 1970s that top spot belonged to Kmart. Now Wal-Mart is the leader, the ghost of Woolworth is called Foot Locker and the Sears/Kmart combo is in serious decline.

[bulrun100]

IN MY OPINION SEAR'S WILL BE AROUND FOR ALONG TIME BUT SMALLER.IT WILL CONTINUE TO BE A SECOND RATE RETAILER BUT AS THE ECONOMY TURNS THE SALES WILL RETURN TO 06-07 LEVELS(BEFORE RECESSION).AT THOSE LEVELS AS WE HAVE SEEN EDDIE CAN GENERATE HUGE RETURNS.WITH THE SHARES REPURCHASED(YES AT HIGHER LEVELS)THE EPS WILL BE 10-20% HIGHER WHICH WILL IN TURN LOWER THE PE.WHEN AND IF THE ECONOMY/HOUSING RECOVERS SALES ONLY HAVE TO RETURN TO 06-07 SALES FOR THE SHARE PRICE TO MOVE TO$200-220.00.BASED ON 6.00-8.00 ESP WHICH WAS 06-07 NUMBERS.ONE MORE THING IF REALESTATE SALES ARE IN EDDIE'S PLAN HE WILL NOT MAKE THE SAME MISTAKE AGAIN HE WILL SELL OFF STORES INCREASING THE CASH ON HAND.BUY SELLING OFF THE STORES THAT ARE UNDER PERFORMING(WELL THE WORSE ONES)THE COMP NUMBERS WILL IMPOVE AS WELL AS PROFITABILITY.ANY ASSET SALES ARE NOT INCLUDED IN THE TARGET PRICE.AS YOU CAN READ I'M NOT SAYING ANYTHING VERY BULLISH OR OUT OF LINE.AS ALL RETAIL HAS GONE WITH THE ECONOMY SO HAS SEARS(LOW,HD IN THE SAME BOAT).

[Newswatcher5]

I find it amazing how every quarter, SHC trots out the same lame old excuses for doing worse than virtually everyone else in retail without once admitting that its failure just might be based, at least in part, on Eddie Lampert's insistence on trying to reinvent retail and failing miserably to do so.

Now he's gonna spend that last billion bucks (of nearly four billion when he started) on even more buybacks of his own worthless shares.

By the time that's done he should have been able to finish polluting the iconic brand names through cost cutting and generally lousy customer service to the point that they're merely empty names, already surpassed by other brands in reputation for quality.

Sooner or later, people are going to have to admit that all that high value real estate he's sitting on is worth exactly what someone else is willing to pay for it and in today's market, given his KMart locations, the fact that many of his Sears stores are in failing malls and the generally obsolete and run down condition of most of his real estate, that's going to be pretty much nothing at all.

And by the time he's done with all that, he should have set even more new records for same store sales decreases and loss of market share. All of this before he has to produce some fertilizer or get off the pot.

It's no wonder he can't get a CEO to come to work for him. What CEO with any reputation at all. especially one specializing in retail, wants to take Aylwin Lewis' place as the front man in what has become a textbook example of how to paint yourself into a corner by bleeding a company to death in three years and THEN deciding maybe ya shouldn't oughta have done some of that stuff?

[CrossProfit]

Very interesting.

Does anyone have an opposing view? Would anyone with a negative short term/long term outlook care to dissect the numbers for us?

CrossProfit

[blah-blah]

Normally I'd call this another bear article trying to push his shorts after the easy money has been made but in this case I can't help but agree with the author.

I don't see a bottom here unless Eddie really does but all the shares.

[CrossProfit]

blah-blah,
Is that 'but' or 'butt'? :)

BTW, no chance he'll take SHLD private, not his game.