Sears Holdings Corporation (SHLD) is a department and discount store chain whose primary concern remains its profitability (driven by the top line), followed by liquidity. The company was able to reduce losses in its 2Q2012 results due to cost containing initiatives, but sales continued to decline. We advise against buying SHLD due to a lack of catalysts that might drive up future sales within the tough competitive and economic environment.
Sears operates in the United States and Canada (95%-owned subsidiary). It has three business segments, namely Kmart, Sears Domestic and Sears Canada. Sears Domestic and Canada have similar offerings, with the latter having more emphasis on softlines like apparels.
Kmart comprised 37% of net sales in 2011, while Sears Domestic was 52%, and Sears Canada 11%.
The company deals in hardlines like appliances and lawn equipment (forming 48.5% of 2011 net sales), apparels and accessories (29.4%), consumables like food (13.8%), as well as repair, installation and other services (8%). Its brand names include Craftsman, Kenmore and DieHard, along with Jaclyn Smith, Lands' End, Joe Boxer, Covington and Apostrophe for apparels. The company claims to be "the nation's largest provider of home services, with more than 11 million service calls made annually."
Net sales dropped 2.6% in 2011 as compared to 2010 due to reduced hardlines sales for Kmart and Sears Domestic. The 5-year CAGR is -4.4% for net sales. Same store sales were down 2.2% in 2011. This resulted in -$3 million net income or -$29.4 diluted EPS.
Recently, the company reported its second quarter results for the period ending July 28, 2012. The company met analyst estimates of an adjusted loss of $0.86/share, which was less than last year's Q2 loss of $1.81/share. This loss was made on the back of a decline in revenues of 7% over last year's Q2. Despite declining sales, margins expanded slightly. Gross margin was up 0.7% compared to the last year due to expense reduction initiatives taken by the company.
Even though losses so far this year are less than those of last year, the company is not out of trouble, as sales continue to decline. Sears witnessed a 2.9% decline in same store sales in the U.S., while Kmart stores saw a larger 4.7% decline. Sears Canada also saw a decline of 7.1% in same store sales. YTD, the same stores sales have declined 6.7%, while for the latest quarter they declined by 7.1% as compared to Q22011. This is the 9th consecutive quarter with negative same store sales. Hardlines and home components led the decline in sales (~$48 million less than last year) in the second quarter, followed by apparels and accessories (~$45 million). Both are the main sources of revenue for the company. Analysts expect sales to continue to decline. The company is also reducing its number of stores.
Sears has a total debt-to-equity ratio of 74%, while the long term debt-to-equity ratio is 44%. The interest coverage ratio is an unhealthy -0.11. Total debt is $3.3 billion, of which $2 billion is long term. Total cash balance is $730 million, while operating cash flow was -$13 million, although it has increased 77% over Q1. In this situation, the company might face problems in repaying debt. It has a $2.4 billion of a credit facility available, but it would worsen the liquidity situation.
Following are some steps the company has undertaken to revive growth:
- Less investment in low growth parts of business.
- Partial spinning off of the 95% interest in Sears Canada. The company intends to keep 51%. This will help improve the prevalent poor liquidity. The spin-off is going to be completed in the second half of the year (probably Q32012).
- Cost-cutting initiatives like efficient inventory management.
We believe that these steps will not be enough for the long run. Instead of selling parts, real estate or business lines, the company should have profitable operations. It should try and turn around the declining sales trend, and concentrate on competitive pricing and promotions.
SHLD faces competition from Wal-Mart (WMT), Target (TGT), The Home Depot (HD), Lowe's (LOW), Kohl's (KSS), J.C. Penney (JCP), Macy's (M), Best Buy (BBY) and Amazon (AMZN) in different categories of its business.
According to a Bloomberg article, prices at Kmart chains are much higher than fellow discounters, Target and Wal-Mart. The difference stands at around 23 percentage points, according to the research. This significant difference is one of the reasons why sales have been dropping at Sears. Consumers are facing unemployment and other economic worries, and are therefore very conscious of where they spend their money. With a difference like 23 percentage points, consumers make their way to Target, which according to the same research, has become cheaper than Wal-Mart by 0.46 percentage points in August 2012. The company has a beta of 1.96, which shows that it undoubtedly suffers from the prevalent economic uncertainty.
While JCP lost customers this year, Sears failed to benefit from this development. Gap (GPS) seems to have attracted some of those customers, as indicated by its impressive July sales.
The company's online sales through myGofer.com, kmart.com, sears.com and sears.ca, face competition from e-commerce giant Amazon, which is pushing for same day deliveries.
The company is trading well above its January 2012's 52-week low of $28.89.
Below is a summary of the valuation measures for Sears, as well as its competitors. By looking at the EV/EBITDA multiple, we see that SHLD's shares are overpriced as compared to better performing (profitable) peers, who have an average multiple of approximately 8x.
The short ratio for SHLD is 19. We recommend staying away from SHLD because of the high short ratio, and because we do not see any stimuli that would drive up sales amidst a very strong competition from fellow retailers.