Teresa Blackwell

Flaws in Jim Cramer's Sears Analysis

I have two problems with Sears. The first is rising inventory levels in conjunction with declining sales. Everyone seems to think Sears is immune from the consequences of this dynamic but when sales go down for a retailer the fixed costs usually don't. Light bills, taxes, salaries etc. have to be paid with fewer sales to cover the expenses. Sears has realized impressive savings by cutting administrative staff but I suspect they are running pretty lean now and can't get much leaner.

Rising inventory levels are even more problematic with the retail inventory method (RIM) which Sears uses. Under retail inventory method Sears counts its physical inventory at retail and applies a cost factor to determine lower of cost or market. That cost factor is an ESTIMATE based on historical sales data. When sales are declining that estimate can get out of whack in a hurry. Rising inventory levels in an inventory calculated on RIM are usually a sign that markdowns aren't being taken, as well. Inventory could be significantly overstated. Since the retail markup is applied to inventory that means sales could be overstated as well.i

My second issue with Sears is the "big cash hoard" that is supposed to exist. Per the most recent quarter $3,690 million is available, but read the fine print and you discover that $441m is o/s checks, $533m is pledged to a letter of credit, $233m is slotted to pension plans in 2006 and $85m is due to claimants in a recently settled lawsuit. That leaves just under $2,500 m for working capital. That is a comfortable amount for a company the size of Sears but not enough to go on a shopping spree.