Sears (SHLD) Still Isn’t a Buy, Despite Its Own Bullishness

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Don’t let the headlines mislead you. Sears (SHLD) may have technically turned a profit last quarter, but there’s a serious footnote current and would-be owners of Sears stock should take into account.

Sears (SHLD) Still Isn't a Buy, Despite the Bullish Earnings ResponseThat is, Sears’ profit was a one-time event birthed from the ill-advised conversion of much of its real estate into a real estate investment trust. Operationally speaking, the Sears earnings report once again illustrated its ongoing deterioration.

In other words, Sears stock is still an ill-advised long shot … on a good day.

Sears Earnings, By the Numbers

In its second fiscal quarter of the year, Sears Holdings earned $208 million, or $1.84 per share of SHLD, on $6.21 billion in sales. Technically speaking, that beat top-line estimates of $5.72 billion. As for the bottom line, though, a closer look at the numbers are merited.

While Sears may have earned $208 million in Q2, it also booked a profit of $526 million last quarter on the sale of 235 of its stores to the recently formed REIT — Heritage Growth Properties. Had it not been for the sale of those properties, Sears would have lost $256 million, or posted a loss of $2.40 per share.

That’s still better than the loss of $2.50 per share of Sears stock the pros were calling for, and better than the per-share loss of $2.76 the retailer booked in the comparable quarter from last year. But, it’s a dubious improvement to be sure. Sales were down 22.5% on a year-over-year basis, and same-store sales were down 7.3% for Kmart stores and 14.0% for Sears.

The Rest of the Story

As could have been expected, CEO Edward Lampert talked up his company’s ongoing “transformation,” while simultaneously offering encouragement to shareholders. He specifically noted within the Sears earnings release:

“The second quarter marked our fourth consecutive quarter of improved results … As our results over the last four consecutive quarters demonstrate, we are successfully enhancing our margin rates and improving EBITDA performance as we become more efficient with our promotional programs and the use of Shop Your Way to replace more traditional forms of marketing with more targeted and personalized digital interactions with our members.”

And, judging from the market’s modestly bearish response to the news (Sears stock was down about 4% in the wake of today’s earnings report), investors aren’t buying into the headlines and Lampert’s rhetoric. Good call.

Simply put, Sears is trying to shrink its way to success. That is, by shedding money-draining and low-margin pieces of its business, Sears and Kmart stores could theoretically return to viability.

And to some extent, it’s possible. For instance, Sears’ gross margins improved from 21.7% in the comparable quarter a year ago to $23.1% this time around. Its EBITDA losses improved from a loss $298 million in the second quarter of 2014 to a loss of only $200 million last quarter.

Investors should be careful with those figures though.

While the size of the loss is technically shrinking, the entire company is shrinking. The EBITDA loss as a percentage of total revenue rolled in at 3.2%. In the second quarter of 2014, the EBITDA loss was 3.7% of sales.

Yes, it’s an improvement, but it’s not game changing. At its current rate, Sears may have to become a company that’s only a fraction of the size it is today to return to a positive EBITDA figure. The more it shrinks and loses scale, though, the more difficult it becomes to turn a profit, as some expenses are static.

So while selling and administrative expenses fell on an absolute basis last quarter, as a percentage of revenue, they grew from 26.4% to 27.3%, largely offsetting the improvement in gross margins.

In other words, actual bottom-line progress remains elusive.

Bottom Line for SHLD

It’s been said before, but it merits repeating now: Sears Holdings doesn’t have a liquidity problem. It doesn’t have a cost problem. It doesn’t even really have a revenue problem. Those are all just symptoms of the overarching issue.

That is, first and foremost, Sears has retailing problem; it is not getting enough of the right merchandise at the right price in front of the right amount of people.

Until that problem is fixed — and a solution is nowhere on the horizon — nothing else really matters.

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

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/shld-sears-holdings-earnings-stock/.

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