Sears Holdings: Expect More And More Store Closures As Results Deteriorate

Summary

• Estimates show a further deterioration in Sears and Kmart foot traffic despite clearance sales.
• Sears' own financial projections show a 13% reduction in expected operating receipts for the holiday season (compared to its mid-October projections).
• Even if Sears can achieve massive non-store level SG&A cuts, it would end up with significantly negative EBITDA with its proposed go-forward store base, due to the deteriorating results.
• More and more store closures are quite likely in the upcoming months, with the weak results increasing the odds of a mass liquidation of the stores.
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Sears Holdings (OTC:SHLDQ) appears to be doing worse than expected during the holiday season. Foot traffic estimates show a larger decline than in previous months, while Sears' financial projections show a 13% reduction in expected operating receipts for eight weeks ending January 12, 2019. This has resulted in it projecting around $90 million per month in cash burn during a period that is typically the best time of year for retailer cash flow.

The deteriorating results push the idea that Sears can be profitable with a smaller store base further away from reality. Thus, I would expect more and more store closure announcements in the upcoming months. The apparently marked deterioration in results also increases the odds of a mass liquidation of stores.

Weak Foot Traffic

inMarket estimated that foot traffic at Sears and Kmart was down 14% during the three days after Thanksgiving 2018 compared to the same period last year. This compares unfavorably to the roughly 6% year-over-year drop in foot traffic at Sears and Kmart from May to August 2018.

The apparent larger decline in year-over-year foot traffic comes despite liquidation/clearance sales at closing stores. Sears' online business is thought to be weak as well, so that is not making up for foot traffic declines.

Downward Revisions To Sales Forecasts

The challenging sales outlook is reflected in the negative revisions to Sears' forecasts as well.

Sears initially expected (back in mid-October) to achieve around $1.934 billion in operating receipts for the eight-week period ending January 12, 2019 (which would encompass the peak holiday selling season).

Source: Docket 7

Sears' updated forecast (from the end of November) has reduced its expectation for operating receipts down to $1.688 billion, a decrease of around 13% compared to its earlier forecast.

Source: Docket 952

This has resulted in Sears now estimating that its operating cash flow would be positive $21 million during that eight-week period, which is a dismal result for the peak sales season given the expected drawdown of inventory during that time as well.

Sears' projection for net cash flow before financing is negative $177 million during that eight-week period, indicating that Sears expects to burn around $90 million per month during the time of the year that is most favorable for cash flow.

EBITDA Projections

It is true that I did not include Sears' Home Services & Warranty business in my calculations that a 505-store Sears would still generate negative $525 million EBITDA per year and would be very far from achieving profitability. However, it appears that much of that business may be already attributed to store-level EBITDA. For example, a warranty sold in store may hit that store's P&L statement.

I will go through some of the calculations that lead to this belief below.

The 505 go-forward stores generated $43.5 million EBITDA during the three-month period ending July 2018.

Source: Docket 729

The other business units mentioned in the docket may contribute around $22 million EBITDA per average month ($66 million over a quarter).

Source: Docket 729

The non-store level SG&A run rate (excluding Home Services & KCD) may have been around $92.83 million per month at the time, adding up to $278.5 million over a quarter.

Source: Docket 729

I had also mentioned $275 million in credit card income per year in my calculations ($69 million per quarter if divided equally).

Adding the above items together results in total of negative $100 million EBITDA for the quarter ending in July.

This excludes the results from stores that aren't part of the 505 go-forward stores though. During the quarter ending in July 2018, Sears had an average of 880 stores. The 375 non-go-forward stores are estimated to have contributed around negative $25 million in four-wall EBITDA during that quarter.

EBITDA ($ Million)	Q2 2018
Go Forward Stores	$43.5
Other Businesses	$66.0
SG&A	-$278.5
Credit Income	$69.0
Non-Go-Forward Stores	-$25.0
Total	-$125.0

Click to enlarge

Thus, we end up at around negative $125 million EBITDA based on the things that I've accounted for in my calculations. Sears reported negative $112 million EBITDA in Q2 2018, which only leaves around $13 million in positive EBITDA during the quarter for things (such as whatever part of the Home Services & Warranty business that isn't attributed to stores) that weren't in my earlier calculations.

Thus, my estimate that Sears would generate negative $525 million EBITDA with the go-forward stores (and its planned headcount reductions) would only change to around negative $475 million with the rest of Sears' businesses added in.

Conclusion

There is various evidence accumulating that Sears' business is deteriorating faster than expected. Foot traffic was estimated to be down more (-14%) during the Black Friday to Sunday weekend than in previous months (-6%), despite clearance sales at a fair number of stores. Sears also reduced its forecast for operating receipts during the holiday season by 13%, leading to its projection that it would burn $90 million per month during two of the most favorable months for cash flow.

My updated negative $475 million EBITDA projection assumes that Sears can't cut non-store level SG&A to $0.6 billion with a 505-store base. The unsecured creditors' committee expressed scepticism that Sears would be able to achieve that magnitude of cuts. I tend to agree with that assessment, but even if Sears was able to do that, it would still end up with slightly negative ($16 million) EBITDA after those massive cost cuts. That doesn't factor in the apparent significant recent deterioration in Sears' business as well. What would probably happen is that even if Sears managed to cut non-store level SG&A by another $459 million, the deterioration in Sears' remaining businesses would eat up those cost savings relatively quickly. This is similar to what has happened in recent years with Sears. It announces major cost cuts, resulting in temporary improvements to EBITDA, but soon Sears is back to where it was before the cost cuts.

Given the continuing deterioration in Sears' business, I do not see a realistic way forward for it to operate with a smaller store base and expect to see more and more store closure announcements in the upcoming months.

Analyst’s 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.