by James Brumley | December 10, 2013 10:38 am
Like every car accident you’re forced to drive around, you just can’t help but gawk at the perpetually worsening disasters playing out at JCPenney (JCP) and Sears Holdings (SHLD). And, although it has become cliche at this point, it’s equally impossible to resist wondering whether JCP stock or SHLD stock will reach the grave first.
It hasn’t been an easy race to handicap. Both retailers seem to have developed a near-weekly habit of giving owners of JCP or SHLD stock a new reason to dump their positions.
For instance, last week’s hit on the value of JCP stock was the announcement that the SEC was going to be poking around a bit, looking for more information regarding the timing and prompting of October’s secondary offering. Meanwhile, Sears officially told us last week that it would be spinning off its Land’s End division. It’ll relieve some financial pressure in the near-term, but Land’s End was carrying more than its fair share of the organization’s financial burden, so it’s not exactly a triumph for SHLD stock.
With all of that being said, it looks like one of the two contenders has taken the lead in their race to the end of the road.
First and foremost, the SEC inquiry is unlikely to unearth anything particularly troubling for JCP stock.
High-profile turnaround stories like the one JCPenney is attempting tend to garner plenty of attention, not to mention drive speculation, which will inevitably lead to an above-average number of investor complaints.
While dilution via the sale of JCP stock (particularly following a comment from the CEO that the company was plenty liquid) is annoying, it’s not improper or illegal. That’s not to say the mere implication isn’t acting as a drag on JCP stock in the meantime, though.
Even once the inquiry is a fading memory, JCPenney still will face a growing number of potentially insurmountable challenges.
While liquidity remains a hot button, at this point it’s not actually the biggest detail JCP stock holders want to focus on; the company has proven it can reconfigure debt and its line of credit as needed to buy time. The biggest hurdle is once again the original one — generating more sales, and turning more of that revenue into a profit.
Obvious? Yes, but not an insignificant problem.
Bloomberg calculates that over the past four quarters, gross margins of 27.9% (of revenue) for JCP stock is the lowest among the industry’s major comparable retailers; the average has been right around 38.4% during that time. The company’s selling and administration expenses are also the highest among the same group.
Were JCPenney able to get the right merchandise in the right place at the right time, the vehicle is in place to improve JCP stock margins and lower (relative) expenses.
Playing a balance-sheet shell game doesn’t accomplish the task, however.
It hasn’t been terribly surprising that hedge fund manager, majority owner of SHLD stock and current Sears CEO Eddie Lampert has turned the company into a real estate play. Many observers hypothesized the possibility way back in 2005 when Kmart and Sears united under the Lampert umbrella.
He hasn’t disappointed, shedding about a dozen stores during the past year-and-a-half, and closing about 300 stores since 2010. More are likely to be on the chopping block, along with the company’s automotive centers.
And truth be told, were SHLD frozen in time, the math might make sense. Baker Street Capital estimated in September that the company’s top 350 stores (out of roughly 2000) were worth $7.3 billion, vs. Sears’ current market cap of $5.08 billion.
Right now, the sum of the parts is greater than the whole.
SHLD stock isn’t frozen in time, however, and the company has been losing a few hundred million dollars every quarter it stays in business. Perhaps even more alarming is the fact that Sears has posted 27 consecutive quarters of declining same-store sales. That’s not total company sales; we already knew the top line has been in free fall for years now. That’s comparable year-over-year sales. The average quarterly sales dip since the first quarter of 2012 is on the order of 2.5%.
Exacerbating the problem is the fact that rather than dumping its weaker stores, Sears is choosing to sell the company’s most profitable locales because they can garner more cash right now. If SHLD stock can’t perform as a whole with its stronger units helping out, how’s it going dig itself out of a hole when its most productive stores are gone?
Ergo, the real risk in owning SHLD stock here isn’t the math of the liquidation. The risk is that as the losses and decline in cash flow start to accelerate, Lampert might become increasingly desperate to unload existing units for increasingly unattractive prices.
So which is the worst of the worst between JCP stock and SHLD stock?
Not that either will make it out of their current predicaments alive, but Sears looks like it’s going to be the first of the two to become nothing more than a memory.
JCPenney seems to want to hold on, even to the point of occasionally being in denial about its ability to do so. Sears Holdings, on the other hand, can’t seem to break itself up fast enough to suit Eddie Lampert. Nevertheless, if a company dissolution is what’s in the cards, SHLD stock owners might want to hope the process picks up speed.
Each quarter Sears remains in business, it loses more money. The more money it loses, the more difficult it becomes to sell its stores no matter how great those locations are, or no matter how attractively they’re priced.
See, once a physical address is stigmatized by bad service or a poor merchandise selection or a deteriorating store infrastructure, the name above the door becomes irrelevant — consumers link the location to a bad experience. Lampert might want to sell as many stores as he can while the company name still has some value. It looks like he’s willing to oblige.
Let’s just hope he can unload the weakest locales at prices they’re actually worth. Otherwise, this real estate play could get surprisingly unfruitful real fast.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
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