What Will Sears Do When There’s Nothing Left to Pawn?

Sears Holdings (NASDAQ: SHLD) has been in decline for a long time. However, the struggling retail icon took a distinct turn for the worse last year. Management has started to close stores at a furious pace, but so far, it hasn’t stemmed the bleeding.

In this Industry Focus video, Vincent Shen and Adam Levine-Weinberg look at some of the moves management is resorting to as they struggle to keep the business afloat. Unfortunately, it may be too little, too late. The company continues to burn cash rapidly, and within the next couple of years, it will run out of assets to sell to offset its operating losses.

A full transcript follows the video.

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This video was recorded on June 12, 2018.

Vincent Shen: We’re going to close out this episode by spending a few minutes catching listeners up on Sears.

Shares for this company are down 90% in the past five years. CEO Eddie Lampert and his team seem convinced that, after messing with real estate, shrinking the store base enough, the company can eventually turn a profit again at some point in the future. I understand the strategy, in terms of doing whatever it takes to pay the bills, keep the doors open. But when you couple it with some of the other moves, like the sale of some of their major brands like Craftsman and Lands’ End — plus, Kenmore is also on the chopping block now — the endgame feels like it would just be a shell of a healthy retail business than an actual going concern.

I’m curious, the Sears situation, what’s the latest, and is there really an ending here that you think investors would be happy with?

Adam Levine-Weinberg: Well, I certainly don’t think there’s going to be a happy ending here. If you look at the first quarter numbers, Sears had another double-digit decline in comparable store sales, 11.9% decline. Overall total sales fell 31%. That’s because you had quite a number of store closures over the prior year. Not surprisingly, with these terrible sales numbers, you also had terrible earnings numbers, net loss of $424 million. The adjusted earnings before interest, taxes, depreciation and amortization, which is the number that Sears wants you to look at because it’s a little bit better, still wasn’t good. It was negative $225 million, which was a little worse than it was a year earlier.

Sears says that they’ve cut $1.25 billion of costs during fiscal 2017. The fact that earnings are still declining, or at least stable, is not good news, because it means that all of those cost cuts basically went to offset the sales declines. That brings up the question, where is Sears going to find additional cost cuts of that magnitude to offset the coming sales declines of 2018? And that’s a pretty big unanswered question.

Meanwhile, you’re seeing more store closures. Sears closed more than 100 stores in the first quarter. In the last couple of months, Sears has announced additional store closures of more than 100 locations. That’s going to take Sears from more than 1,400 locations at the beginning of 2017 to less than 800 by mid-September, a pretty shocking —

Shen: That’s jaw-dropping, that’s absolutely jaw-dropping.

Levine-Weinberg: And what’s the most disturbing is not the store closures themselves but the fact that Sears will keep telling investors, “We’ve identified some stores that are not profitable, which we’re going to close in order to improve our profitability.” The stores close, the profitability doesn’t actually improve. And that just goes to show that the profitable stores are ever-so-steadily moving toward unprofitability. So every year, there’s another crop of stores which have magically become unprofitable because of the sales declines and margin declines over the previous year. That’s a pretty bad situation.

Now, Sears’ stock has been pretty volatile. You’ve had some big bounces over the past few months in addition to the longer-term decline. Some of the things that drove the gains for Sears’ stock were, they just closed a $400 million payment they got from Citibank, which is their credit card partner. That was a payment to extend their existing partnership. They offer this Shop Your Way credit card, which offers a variety of rewards. It’s set up, structured, to be a little bit like the Costco credit card, which is also issued by Citibank. The difference is that lots and lots and lots of people shop a lot at Costco. The same can’t be said for Sears. It’s a lookalike, but it’s not nearly as successful. However, Citi did make this payment to extend the agreement and also to buy out Sears’ interest in some of those credit card accounts. That definitely was helpful, because it’s giving a cash infusion that will keep the company alive for a little bit longer.

However, Sears burned almost $2 billion of cash last year, and Sears seems to be on track toward a similar level of cash burn in 2018, before possibly having a little bit of improvement in 2019. The problem is that, over the past several years, Sears had a huge number of assets that it could sell to fill the gap and pay for its operating losses, and it’s really running out of assets to sell at this point. The company does own a bunch of real estate. It owns that Kenmore Appliances brand that it’s looking to sell. Sears is also looking to sell parts of its Home Services unit. ESL Investments, which is Eddie Lampert, the CEO’s, hedge fund — he runs a hedge fund in addition to running Sears Holdings — ESL has announced that it’s interested in buying some of these assets.

The problem for Sears is that almost all of its valuable assets are now encumbered in some way. That means that they’re being used as collateral, either to support its debt or support its pension obligation. Sears has over $5 billion of debt and a pension deficit of more than $1 billion, so there’s really a lot of money that’s being called for by these different commitments that Sears has made over the past few years.

The result is that, even if Sears does manage to sell all these assets, a lot of the proceeds will need to go to paying down the debt and contributing it to the pension plan. That won’t leave a lot to plug further gaps in its operating losses. As a result, I think it’s going to be pretty difficult for Sears to survive past late 2019 or early 2020. The company does seem to have enough liquidity to make it to the end of this year, but it’s definitely confronting a problem, and there’s no clear solution. The underlying retail business has become so bad, it’s just in terminal decline at this point.

Adam Levine-Weinberg has no position in any of the stocks mentioned. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.

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