I’m not sure what’s been more difficult: watching the debacle that is retailer JCPenney (NYSE:JCP) where I bought my first business suit (1977, blue corduroy), or the dismantling of Sears (NASDAQ:SHLD), where I bought my first baseball glove (1964, Rawlings).
In either case a little bit of personal — and I suspect collective Americana — is crumbling before our very eyes.
I take the SHLD case with disdain, mostly since I put forth a case late last year that appears to be coming somewhat to fruition, and I take no pleasure in the outcome: a smaller retailer with lots of real estate holdings. I truly believe master investor Eddie Lampert has no interest in improving Sears’ retailing future.
Lampert spun off its Sears Hometown and Outlet Stores (NASDAQ:SHOS) in October and closed down smaller stores and outlets in the U.S. and Canada to help streamline the company. In its fourth quarter, SHLD’s revenues dropped 2% to $12.26 billion, which Sears mostly attributed to the SHOS spinoff. Still, revenues were slumping long before this (as shown below):
To be fair, Lampert believes he’s making strides to reverse the trend, suggesting that despite a tough retailing environment that includes Walmart (NYSE:WMT) and Target (NYSE:TGT) among a host of competitors, Sears is investing in growth through in-store improvements which includes a sharper focus on inventory levels (particularly in durable goods) and arming salespeople with iPads and other devices.
And that’s apparently about it on the spending end. Sears has a negative five-year capex rate, and last year’s full-year capital spending came in at just less than 1% of SHLD’s $41.5 billion in revenue.
Sears is nowhere near profitability, either, but the losses aren’t as bad as before. The company managed to reduce expenses — particularly in advertising and supplies, and also via a $395 million (excluding SHOS) reduction in inventory.
Still, what’s really going here is an attempt to profit merely through cost-cutting and better inventory management, reduce debt (mostly caused by the initial leveraged buyout in 2008) and increase cash.
But where the heck is all that cash going? Back in mid-2010, Sears had more than $1.5 billion in cash; that’s now down to just more than $600 million. Well, here’s at least part of the answer, per Sears’ investor press release:
“The decrease in cash during 2012 was primarily due to contributions to our pension and post-retirement benefit plans of $593 million, capital expenditures of $378 million and repayments of long-term debt of $335 million.”
Sears has a very large stock buyback program (though it, like so many others, is not very good at it), but Lampert has slowed down the plan to reflect weaker free cash flow; Sears spent just more than $600 million to buy stock in 2009, but that fell to less than $200 million in fiscal 2012.
No, the money has been headed to debt payments. Sears’ debt load is now “down” to $3.1 billion from a peak of just more than $4.4 billion in October 2008, with quarterly interest expense alone in running close to $70 million. Sears managed to pay down $400 million toward principal last quarter.
So, to sum it up, we’ve got …
- No real plan for organic revenue growth.
- A shrinking store base, bending to tougher competition.
- Cost cutting and little capex growth that results in better margins and cash flow.
- Asset sales that can continue as long as real property is available.
So where are we going?
My guess is this is eventually going to result in a retail operation disguised (but not substituted) as a stripped-down real estate investment trust. If nothing else, even after closing non-performing locations, Sears has a treasure-trove of properties and leases in its inventory that could provide a nice payday for Lampert and investors over the long haul.
According to Barron’s, Privet Fund analyst Cliff Orr thinks there’s “substantial unappreciated value in Sears’ real estate. Many buildings are decades old and carried at antiquated valuations on its books. Moreover, many Sears stores in malls have long-term leases far below market rates, which could tempt landlords to buy them out and repurpose the space.” Orr believes SHLD could be worth as much as $100 per share in such a scenario.
Indeed, Lampert could slowly unwind the real estate while continuing to slim down the stores to sell what’s left of Sears’ brand merchandise, paying down debt as he goes to help generate cash flow. Lampert doesn’t necessarily need to spin the whole company off as an REIT without having one already in principle.
And I wouldn’t exactly suggest the company will liquidate, since that provides no real profitable endgame.
So what’s an investor in Sears supposed to do? It’s tough, but personally, I wouldn’t want to be in this stock.
I believe Sears will never again be a power retailer capable of any extended growth, and any gains from real estate sales will simply drop to payments on debt service. Cash flow? Virtually nonexistent, which means for the foreseeable future no dividends, either.
That means no future investment on my part.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he does not hold a position in any of the aforementioned securities.
