Another year has gone by and Sears Holdings (NYSE: SHLD) manages to captivate investors.
Possible Confusion On Asset Sales?
There appears to be another error in the financial presentations released by Sears. We cannot say for certain that this is an error, but the evidence seems to suggest it is. Slide 8 of the Investor Presentation for Q4 of 2016 shows a chart that has some bullet points in a box. We provide a copy of the slide below. To be 100% clear we have added the red circle, the red arrow, and the text box to the right of the arrow.
The highlighted section says that Sears received proceeds of $105 million from the sale of three properties in March 2017. If we turn now to the press release announcing Q4 2016 results released on March 09, 2017 we see the following language:
In addition, we received gross proceeds of $72.5 million in January 2017 from a sale-leaseback transaction for five Sears Full-line stores and two Sears Auto Centers and we received an additional $105 million of gross proceeds in February 2017 from the sale of three Sears Full-line stores (one owned and two leased), which we will continue to operate as Sears locations for a period of up to one year.
We added the bold for emphasis. In the press release we see that Sears received $105 million in Feb. 2017 for selling three properties. First, are these $105 million transactions the same? If that is the case than one of the months (Feb or March) is wrong? Now it could be that these are two different transactions. And the terms just happen to be the same. But we would think the chart would show both transactions if that was the case. We make our fair share of mistakes, so no judgment here, but this presentation has another important issue.
The chart above is misleading for a different reason. The box on the slide presented above says that Sears 'Total Liquid Availability' increased from Q4 2016 by approximately $775 million. And then the chart says that "The increased liquid availability reflects:" After this is the three bullet points that list different information. One being the $105 million line we quoted above. But think about this information. If the transactions took place in February or March, then they were not during the Q4 2016 which ended January 28, 2017. The second bullet point from the top of the chart says that the $775 million of additional liquidity comes from executed transactions. But how does one execute a transaction in Feb or March and have it apply to balance sheet as of Jan. 28, 2017. There are many complicated accounting rules that impact this decision. But usually accounting rules favor conservative accounting. If the sale was agreed to before Jan. 28, 2017, then sometimes the company will show the loss on sale of assets immediately, and then show the cash being received in a different quarter. In those instances, the company will usually say that the deal is certain to close. But showing the gain and the transfer of cash or impact of cash that hasn't happened by the date of the balance sheet is not usually permitted by accounting standards.
Next, there is a concern with the cash number being reported on the balance sheet. The increased liquidity shows cash of $286 million. We always like to try and follow the cash, if we can't understand what is going on with a company's financials. But in this case, it becomes near impossible. If the transactions took place in either March or February, then it would appear to us to be misleading to suggest that cash, and debt listed as of January 28, 2017 benefited from this transaction. If the transaction took place before Jan 28, 2017, then why does the press release and the presentation say differently. And when was the cash received? There could be a scenario where the transaction was entered prior to Jan. 28, 2017 and the money was received after that point. But this still doesn't explain why the months are different.
We next turned back to the original press release and we can see from the financials that Sears Holdings shows a gain on the sale of assets of $81 million.
We know that Sears sold $72.5 million of properties in January. But this is gross proceeds. Not the gain on the sale. There is no way to see how much of the gross proceeds represents a gain relatively to the properties carrying costs. Once, we have the 10-K we can make this determination. Also, Sears could have sold properties in November and December and just not reported them in this press release. Also, the press release dated 2/10/2017, does not highlight the $105 million-dollar sale. It does highlight the $72.5 million-dollar sale. At the end of the day, the $105 million-dollar transaction leaves us very confused. Maybe just as confused as the person putting this information together. The $105 million in question represents 13.5% of the increased total liquidity of $775 million suggested by the chart.
If we are right, then investors must ask why this is happening? Is management becoming more and more aggressive in trying to communicate the company's financial stability? Or is it simply human error? And if it is an error, how is the company going to respond to prevent similar issues from arising?
Pension Fund Secures More Assets
We wrote an article discussing how the Pension fund had to approve the Craftsman deal. We urged the PBGC to not approve the deal. They chose to do otherwise. Instead they decided to try and extract more value for the pensioners by placing additional liens on assets owned by Sears. The relevant language appears on page 3 of the press release dated March 09, 2017.
The PBGC gets the following:
- The value of the $250 million cash payment in year 3 of the Craftsman deal
- A lien on the 15-year royalty stream created because of the Craftsman deal
- A lien on $100 million of additional real-estate.
These steps highlight a point we have made many times before. The money being generated by the sale of these assets is not being used for new capital allocation decisions. Here the money is going to plug operating losses and pension deficits. This does help the equity holders in some way because it lowers the liabilities owed.
One of the most frustrating things about Sears is their continued insistence on showing how the impact of a 1% increase in interest rates lowers the pension obligations by $500 million. You can find the relevant language most recently articulated in the transcript to the most recent earnings found here. The most egregious issue is that Sears fails to caveat these statements with how a 1% change in interest rates will impact their floating rate debt. If you want the benefit of something than show how that same change will impact the business in the negative. If Sears was a financially healthy company than maybe this would not be a big deal. But their approach assumes that Sears has enough cash to survive until interest rates move. Also, interest rates are not something the company can control.
Another example of Sears doing this, is every time Sears announces the savings from closing stores, but does not include the cost of closing those stores. The costs have both cash and non-cash charges. To say that you will save X amount of money overtime, without discussing the cost of that savings is questionable behavior. Again, if Sears was in a financially strong position, then this might not be an issue. But how is Sears going to pay for these closures? Our guess is by selling more and more stores.
Cesar Alvarez has resigned from the board of Directors.
On March 16, 2017, we learned that Cesar Alvarez has resigned from the Board of Directors. Cesar works for Fairholme, and represents Bruce Berkowitz. Cesar was elected to the board of Sears on Dec. 18, 2013. The press release said that Cesar was retiring from the Sears board. We haven't been able to find any information that Cesar is retiring from his other positions. So, is Cesar really retiring, or is he just stepping down.
We believe that investors should be cautious with making any investment into Sears. Sears Holdings, is a massive company and trying to right the ship is near impossible. But management should be presenting the issues in a clear and concise way to allow ALL investors to make their own informed decisions.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.