Sears Remains a Compelling Short

| About: Sears Holdings (SHLD)

Sears Holdings (NASDAQ: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 (NASDAQ:COST), Big Lots (NYSE:BIG) and Wal-Mart (NYSE: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

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