SHLD: Same Fate as JCPenney, It’s Just Taking a Different Route

by James Brumley | October 10, 2013 11:44 am

The common thread between JCPenney (JCP[1]) and Sears Holdings (SHLD[2]) isn’t exactly a big secret. Both department store chains are struggling, largely due to misguided management. Between the two, though, there’s little doubt that one’s assumed to have a reasonable shot at survival (Sears), while the other (JCPenney) is destined to careen off a cliff.

Take a closer look at SHLD, however, and you might find both are headed for their ultimate demise. They’re just taking different routes.

JCPenney Is Bad …

JCPenney’s woes have been more than adequately documented. Ron Johnson effectively drove the company into the ground in an effort to make the value-oriented retailer look and feel like Apple (AAPL[3]) stores, and it didn’t work. While he was finally ousted and former CEO Mike Ullman stepped back into the role in April, by that time it was too late.

Yes, Ullman seems intent on restoring JCPenney to the semi-successful department store chain it was just a few years ago, but we’ve yet to hear any plausible plans that will actually make that happen. So far, we’ve only heard an “all is well” assurance from the company … a company that just went to the open market to raise $785 million, tapped into $850 million worth of a revolving credit line, and took out a $2.25 billion loan earlier in the year.

It certainly alleviates the liquidity concern; the retailer expects to be sitting on $2 billion in cash at the end of the year. But, if every bit of the cash on hand (and then some) was borrowed or raised in just the past few months, it’s difficult to say Penney’s is in a viable financial condition.

JCPenney is still very much on life support, and could easily slip away if sales continue to fall short.

Fortunately for Sears, it’s not in the same liquidity crunch, right? Well, it might not have the same illness, but it doesn’t appear to be any less terminal.

… But Sears Is No Better

In some ways you have to admire Eddie Lampert’s willingness to make tough decisions. On the other hand, when Lampert is the only person on the planet who can’t see the forest for the trees, it’s got to be exasperating for SHLD shareholders.

The folks who originally said Eddie Lampert — hedge fund manager, major SHLD shareholder, and now acting Sears CEO — was mostly viewing Sears Holdings as a real estate play have since been vindicated. In addition to the spinoff of Orchard Supply Hardware (OSHWQ[4]) in 2011 and last year’s spinoff of the relatively successful Sears Hometown and Outlet Stores (SHOS[5]), Lampert is now finally getting serious about shedding SHLD department store units. Last year he sold or closed 46 of the company’s 1,300 or so full-line mall stores[6], vs. letting go of less than 10 in any year since he became a major shareholder back in 2006.

Why? Because selling these stores puts much-needed money into the struggling retailer’s bank account.

While SHLD isn’t particularly forthcoming with details in the operation or sale of individual stores, we do know that Sears has garnered $277 million through the first six months of the current fiscal year via the sale of units or the exit of leases. That number lines up with the company’s aim of pulling in $500 million this year by axing some of its real estate.

Sears Holdings firmly implies that it’s just trying to cull the stores that are a drag on profits, but at least a couple of the stores Lampert has let go of recently are among the organization’s most profitable units located in some of the country’s highest-traffic malls. Why would he let go of such assets? Because the offers — to Lampert, anyway — are just too good to refuse.

There’s just one problem with the approach … it’s not viable for the long haul. Indeed, given enough time, it’s almost a guaranteed loser.

Even if most of the stores Sears is cutting loose of are dead weight, the 80/20 rule largely applies in the world of retail — 20% of Sears’ department stores provide 80% of … well, we can’t say “profits” because the company is habitually losing money; it lost $985 million last year, and is on pace to lose nearly twice that this year. Let’s just say 20% of the company’s units make up 80% of the company’s value. Booting even just a handful of the very best stores (because the payoff is strong) still knocks out a huge chunk of the company’s ability to produce revenue, and more important than that, the ability to produce profits.

It’s a nice short-term fix, but the whole point of retailing is to build a machine that produces recurring — and growing — revenue for years to come. Booting even just a few of your best profit centers makes things worse, not better.

Bottom Line

As long as Lampert is willing to sell Sears stores to raise cash, the company won’t need to make any kind of secondary offer the way JCPenney just did. SHLD had $681 million in cash on the books as of the end of last quarter, and seems to collect tens of millions (though the amount can vary widely) each time a store is sold. But, until Sears can actually address the reason it’s bleeding money, carving out pieces of itself only buys time.

And, therein lies the problem … Sears Holdings doesn’t seem to have any understanding of why it’s losing money, and therefore doesn’t have a viable plan to turn business around.

Eventually Lampert is going to run out of attractive stores/locales to sell. It might take a while, but it’s going to happen sooner or later. That’s when the company is going to face a serious JCPlike cash crunch, which for retailers usually marks their final days.

Hopefully Lampert will give up on the whole thing and abdicate his position before he chops off too many of the organization’s most vital organs, as someone else who “gets” retailing could still save the company

Lampert appears to be entrenched, though; the outlook for SHLD doesn’t look encouraging.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:
  1. JCP: http://studio-5.financialcontent.com/investplace/quote?Symbol=JCP
  2. SHLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=SHLD
  3. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  4. OSHWQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=OSHWQ
  5. SHOS: http://studio-5.financialcontent.com/investplace/quote?Symbol=SHOS
  6. sold or closed 46 of the company’s 1,300 or so full-line mall stores: http://online.wsj.com/news/articles/SB10001424052702303643304579109023202738550

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