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Sears Faces Risk If Economy Doesn't Improve

by: Frank Rong August 07, 2008 | about stocks: AZO / SHLD    

Frank Rong

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When management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it's the reputation of the business that remains intact.
- Warren Buffett

Eddie Lampert has a simple strategy when it comes to investing: Buy a large portion of stock in a particular company in which he can influence the management, cut expenses at the company and use the money to buy back stocks. He has been successful so far. Autozone (AZO) is a great example.

However, his last major investment in Sears Holdings (SHLD) may prove to be a fatal mistake. Sears Holdings owns Sears and K-Mart. The bulls's argument in Sears was this: Eddie is the next Warren Buffett. Eddie can sell out many Sears properties and use the proceeds from the sale to invest in other businesses where he can produce a better return than he can in retail. I think that argument may be flawed for two reasons:

1. Buffett actually said investing in Berkshire Hathaway (BRK.A) was one of biggest mistakes he ever made. Buffett made money by investing in great businesses, not in bad businesses that he tried to turn around.

2. It's the economy, stupid. We are in a recession, sales and profit margin are falling year over year at Sears. Commercial real estate values are falling. Eddie wil unlikely sell any property at an attractive price anytime soon. In recent years, under the leadership of Eddie Lampert, Sears cut marketing expenses to the bone. There's nothing left to cut. In its latest quarter ended May 3, 2008, the company posted a pretax loss of $64 million vs. pretax income of $381 million in the same period last year. As the economy gets tough for some extended period and the housing bust continues to get worse, departement stores like Sears will lose more business to the discount retailers. It will be increasingly more diffcult to turn a profit at Sears and K-Mart.

Sears Holding has bought back $2.96 billion dollars worth of stock in 2007, and that leaves Sears with very little or no money on hand to endure an economic downturn. That stress has clearly shown up in its latest quarter, as it had to borrow $646 million dollars in short term commercial paper to cover some cash flow issues.

I have a hard time believing that Sears will turn a profit this year, with almost $10 billion dollars in total current liability, and only $13 billion dollars in current assets, mainly comprised of $10.3 billion in inventory.

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This article has 32 comments:

  •  
    Aug 07 04:51 PM
    I hope this nice piece of journalism helps you and your acquaintances get out of your short position before the next quarterly report.

    Can you outline the bankruptcy scenario?

    Reply
  •  
    Aug 07 05:14 PM
    This is a joke, right? SHLD has about 1.4 billion in cash on its balance sheet, only 3.5 billion in LT debt, is free cash flow positive, and they're going to file bankruptcy??

    It's nice to know that any idiot with a computer can now play financial analyst. I've never seen a more fitting last name..."wrong&quo...
    Reply
  •  
    Aug 07 06:57 PM
    Mr. Rong needs to better back up his assertions but he's directionally accurate. SHLD has negative free cash flow from operating activities, which is the best measure of the health of the enterprise. <$517MM> reported for 13 weeks. Mind you stores of course do their best Q4 but nonetheless this is a lousy number to post, and we're in the teeth of a tough retail environment. The strong get stronger and the weak get weaker in the shakeouts.

    Walk into a Sears. Awful -- the stores look like a third world retailer. Their best hope is to license their brands like Craftsman, Die Hard etc. As a retail operator, they are only going down.

    For latest cash flow statement see yahoo.brand.edgar-onli...
    Reply
  •  
    Aug 07 07:12 PM
    >>>It's nice to know that any idiot with a computer can now play financial analyst. I've never seen a more fitting last name...<<<

    When Lampert started his little one trick pony show, Sears had almost FOUR BILLION in cash reserves, it's stock was flying high, it's name brands hadn't been watered down and it hadn't suffered through 4 years of 4-5% sales declines every year.

    All the writer is saying is that Lampert's attempt to be a retailer has been a dismal failure and that economic conditions no longer favor him being able to bail himself out with real estate and other asset sales, which is pretty obvious even to those of us who lack your financial acumen.

    If your going to be a critic, maybe you could also tell us what new tricks the heretofore one trick pony has learned and may be pulling from whatever dark place he keeps them in to save the day.
    Reply
  •  
    Aug 07 07:30 PM
    Sears will go bankrupt at least 6 months later than JCP, Dollar Store, and Home Depot. Too much cash, too much undervalued real estate. The Kmart part of the business will be totally sold before SHLD goes under. DO NOT SWEAT a Sears bankruptcy. This WILL NOT happen.


    Jay

    irelandcheap.com
    Reply
  •  
    Aug 07 07:38 PM
    Some points of interest missed by everyone in the discussion above me.

    Credit line availability is currently 2.5 billion and does not include a pledging of real estate assets. Credit line expires in Mid 2010.

    Authorization on buyback is down to $143mm so even if lampert wanted to do something stupid, I doubt he could make it fly.

    So, even if sears continues to burn cash at $1 billion per year, it has availability under its credit lines to meet that cash burn rate. In addition, any time additional cash is needed, they can shut down non-performing stores and sell off the real estate. Or they could enter into a large sale-leaseback with any number of REITS that specialize in this. This could generate significant amounts of upfront cash for SLHD.

    Could things get worse than an annual $1 billion burn rate, sure could, but they have time to make changes to correct things as it stands now - whether they can or will is yet to be seen

    Kind Regards
    Reply
  •  
    Aug 07 08:08 PM
    The $143 million is left over from a prior authorization, since then SHLD has been authorized to buy back an additional $500 million.
    Reply
  •  
    Aug 07 08:37 PM
    Sears no longer stands behind their products and both Sears and KMart are ugly, poorly maintained stores. If Target is hurting and Wallmart are advising of pending problems, what could possibly interest anyone in SHLD? To paraphrase an old 'lawyer joke"; "What's the difference between Sears and a catfish? One's a scum sucking bottom dweller and the other is only a fish." OK... Scum sucking may be a little harsh.. Still ...

    jegan ;-)
    Reply
  •  
    Aug 07 09:06 PM
    The Writer actually said that sears will go bankrupt.

    this was unsubstantiated by any fact other than first quarter cash flows from operations being negative.

    Wall street and the average Mad Money fan have no idea how to evaluate a company that doesn't pander to wall street convention.

    Same store sales declining? fine, invest the money elsewhere.

    The Shorts are chained to the railroad tracks on this deal.
    Reply
  •  
    Aug 08 07:02 AM
    it just shows that there are no investing geniuses out there...if things go well in economy..everybody looks like a genius..when things get worse, they all become humans again
    Reply
  •  
    Aug 08 08:36 AM
    Lampert wants to prove to his mommy and himself that he can turn a failing retailer around.He is a billionaire and makes his money from his hedge fund ESL which in one year he made a billn dollars in fees.

    He personally owns around a million shares of Sears,which is nothing because he is worth billions.The bulk of Sears is owned by his hedge fund,in which is using other peoples money,in which he gets his fees,how convenient.

    Think of his personal holdings in Sears as a write off when its needed.

    His focus and investing strategies are focused on ESL,,where he gets his fees.

    The next Buffett,,,please.

    What is doing with the surplus of cash from Sears
    which he has full investing authority,,,he buys back sears stock at higher prices no less.How about that purchase of Citi at its highs....real Buffett like.(IN ESL)

    In short investors thought when they bought into sears they were buying into a Lmapert hedge fund without the enormous investment needed to get into ESL.This made the stock take off,,,after reality set in big and small investors bailed out.
    Reply
  •  
    Aug 08 08:59 AM
    bankruptcy is ruled out for shld. however, Lampert might be forced to sell the assets rather quickly now. if you liquidate the entire company, even in todays market environment you will get substantially more than the current $80/share. however, pure liquidation was not Lampert's objective and was certainly not see as the value maximizing option. But it served and serves as a sort of back-up.
    That being said I won't invest in shld even though it trades way below liquidation value. Lampert has proved to have no clue of how to run a retailing company not to speak of turning around one. chances are he continues to burn more cash and sink more money . Of course, very smart guys like bruce berkowitz from fairholme make the case for sears that you get eddie lampert essentially for free when you buy sears. However, I do not appreciate a guy like Lampert - so i do not want the fellow even for free
    Reply
  •  
    Aug 08 09:04 AM
    It will start with the shutdown of poor performing stores. Some of which are 1st or 2nd tier anchors for a lot of malls. Then it will spin on down further as the recession continues.

    They are consuming themselves to stay alive through the next 2 to 3 years till we finally get on the road to recovery. The question is: "Can they survive the next 3 to 4 years for the recovery to kick in?"
    Reply
  •  
    Aug 08 09:36 AM
    I used to work for Sears, it was great from '85 until '91, then the bottom fell out. I've gone to Retail-Worker.com and you should read what the employees are saying. They're all looking to bail out before Sears goes under. Sears was a good company, the magic show is over and the company will be in bankruptcy. It will not be a surprise to all of us who work or did work there. When you go into a store, you do not see alot of customers.
    Reply
  •  
    Aug 08 09:58 AM
    Do not worry, Sears won't go bankrupt any time soon. They'll sell store after store after store to some Chinese owned retailer that will then import all their low wage products into the US and take market share from other low priced retailers.

    The thought of Sears going bankrupt is sorta like that crazy idea of Ford going bust, or GM, or the airlines, or newspaper companies. That could never happen. Or Could it?

    When its all said and done, we'll all be working for Walmart, or Google.

    Jay Fredrickson


    washingtoncheap.com
    Reply
  •  
    Aug 08 10:10 AM
    When I was growing up on Lond Island in the mid 1960-'s - 70's,
    it was tough to beat Sears for value and quality. Our home appliances
    were all from Kenmore. Just about every tool or piece of yard equipment my dad had was from Craftsman. Alas, no more. Mr. Lampert needs to focus on the basic blocking and tackling of running a department store that was known for value and quality and skip the financial engineering. Six years ago, I purchased a
    storage freeezer from Sears and the sales person could not complete the paper work because he was illiterate. Three years
    ago Sears Home Services was contracted to clean our ventilation ducts. The job performed was so abysmal I had to threaten court action. Just recently, I received a phone call from a Sears telemarketer. The woman on the phone spoke to me in what could only be called conversational eubonics. I wish I had taped the phone call so Mr. Lampert could have heard it. Your ship is sinking Eddie and your money is going with it.
    Reply
  •  
    Aug 08 11:02 AM
    Sears- "Where America Doesn't Shop"
    Get over it.
    Reply
  •  
    Aug 08 12:51 PM
    There is a dichotomy here that is similar to Buffet and Berkshire you are investing in the manager more than the company. This type of investing can be riskier than most because of such a large relaince on one person. What if Berkshire lost Warren? What if Apple lost Jobs? What if Eddie was making bad bets without proper checks and balances?
    Reply
  •  
    Aug 08 01:17 PM
    SHLD sure does have a lot of revenue ($50 billion) for being a store that nobody shops at. TGT (where everyone apparently shops) has revenue of 63 billion.

    If you look past the changes in working capital, which will reverse themselves because SHLD isn't growing, they generated + cash flow last quarter.
    Reply
  •  
    Aug 08 03:48 PM
    THIS POST IS PURELY TRASH!LLLLOLLLL MUST BE A SHORT WHO IS GETTING KILLED SINCE THE MOVE FROM $67-91..........LOL KEEP SUFFERING
    Reply
  •  
    Aug 09 01:36 AM
    I work for Sears and I would hate to see them go in to Bankruptcy. Closing underperforming stores might help them get their feet planted more firmly on the ground. I have Kenmore ap[pliances, craftsman tools and all kinds of products from Sears. Our economy is rough right now , the housing market, stock market even at the Banks, very little return for your money. Lets hope that things can tunn around but I don't believe that it will happen over night. I started working for Sear's in Georgia in 1963 when my Daughter was 3 months old. She is 45 now.
    Reply
  •  
    Aug 09 10:04 AM
    SHLD is facing headwinds and I think it is sfae to say that Lampert's strategy is not working. The Company has a leadership problem. A key difference between Eddie Lampert is that Warren stays out of his management's hair (except in extraordinairy circumstances) while Lampert does not seem to know what he does not know.

    However, the company is generating positive cashflow (the last quarter may be just an anomaly becuse of seasonal inventory build up), the compnay enjoys appropriate liquidity. The call for risk of bankruptcy is entirelly premature and not based on facts.
    Reply
  •  
    Aug 09 01:26 PM
    Blah Blah Blah... Economy is crappy, SHLD is bad. Economy gets better, SHLD gets better. If SHLD goes bankrupt, we are all F'ed in the A. Saying sears faces bankruptcy is like saying VLO is going to collapse. Real assets = real assets folks...
    Reply
  •  
    Aug 09 03:38 PM
    I retired from Sears after 29 years and Sears just NEVER GOT IT!
    Every now and then they would think they had reinvented retail with their silly buttons and slogans that we had to wear on our shirts.
    One time it was "We're empowered." We would have men come us to us and say what are you iempowered to do?
    IF ONLY THE WHEELS WOULD HAVE ASKED THE $3.35 AN hour employees, assoiciate, whatever they decided to call us, we might could have helped saved Sears. But no, we were ruled by intimidation. Except for my very best friends still employed with
    Sears, I always prayed I would live to see some of those idiots
    loose their jobs and Sears go down the tube.
    Sears' main problem was that when someone was brought in off the streets or promoted, that person thought they had just been handed the "key to the city." And the intimidation would begin all over again. I pray for my friends that this does not come to pass unless they all get other jobs and then let "wrecking ball begin."
    Reply
  •  
    Aug 09 07:47 PM
    He is probably on his yaht simping champage and eating cavier.

    Reply
  •  
    Aug 10 03:30 PM
    I have been at Sears for a number of years and I can see something in the making. Just not sure what it is. I think Sears decline is the result of so many getting promoted into management that are not qualified for the position. If you know the right person you can be promoted into management in less than 5 years such as was done in our store. And you can have a store manager with as little as 10 years experience. We have one of those, also. Sears use to pick and choose who they promoted and Sears prospered. Now it is who you know and not what you know. Sears has lost it's focus on customer service. Too much is expected of associates and not enough hours given to complete the work. And whatever you do don't expect management to help with the work because that is a thing of the past, also.
    Reply
  •  
    Aug 11 01:01 PM
    A comment back to "notsurprised.&qu... Sears did this and does this because no one that has any sense wants the management jobs . All the good ones are retired or left when they acknowledged Sears had no idea on "God's green earth" what to do with itself!!!!
    I would love to know if Walmart has tried as many "bright ideas" as Sears has put forth. Sears has not yet made up its mind who should do the signing, address the dress code, etc. Folks outside of Sears would have no idea what goes on behind "those walls." We had a junior high school teacher work part time in the hub, (they are still not sure what to call their back office) and she said, "it was more stressful to work a few hours at Sears than to teach school all week." Folks when you walk in a Sears store, you have no idea what kind of stress those 6.15-7.00 an hour associates are under.
    In my 29 years, there were two managers that were tops!!!!!!
    Let me give you an idea of how crazy these mgr's can be. It snowed really bad and I was the only one to drive to work and the mgr. made me move my car off the lot where customers would normally park.. There were no customers that day. I am sure I went in due to payroll or something that had to be done to put my life at risk. He did not last long. The worse thing that I lived through with Sears was the fact they would post a job, lead folks to believe they really had a chance at it knowing all the time they
    were bs'ing everyone. Sears is the most unethical company and has managers that would stab their grandmother in the back to get ahead. NO ONE WAS INTERESTED IN THE BOTTOM LINE; JUST THEMSELVES. The wheels could not see it and would not listen.
    We all said, "what goes around, comes around," and we may just be beginning to see the "coming around."
    Reply
  •  
    Aug 11 03:16 PM
    I worked for the great indoors - a sears holding store in Gaithersburg, Md. (DC metro area) for almost 2 yrs. I used to be a customer there also - when the store first opened in 2001 it was crisp, innovative and packed. It didn't scream sears/kmart like it does now. The managment turnover is unbelievable, most of the employees there (70%) don't speak english and are hired as part times to avoid any benefit liability. The moral there is very bad - 90% are unhappy, underpaid, overworked and disgruntled. Its an awful place to shop and work - I hope it SHUTS DOWN sooner than later!!!!!!!
    Reply
  •  
    Aug 12 12:38 PM
    "He is probably on his yaht simping champage and eating cavier."

    Funny, but that's the essence of the problem here, isn't it? When your boy wonder has more money than god, what's going to motivate him to bust his butt to prove doubters wrong? You guys believing in his black box magic had better hope he's a guy with a massive ego, otherwise he'll do what any sensible billionaire will do and walk away to enjoy life in the Hamptons and let someone else sort it out...
    Reply
  •  
    Aug 12 06:31 PM
    Sears will probably not go bankrupt, but it will trade much lower. The real estate is not worth anywhere near the optimistic values based on assumptions made at the real estate peak. Watch for some data points on pricing coming out of the Mervyn's bankruptcy. Cap rates are headed up and rent per square foot is not going up, particular for locations that show declining sales. Given that Sears is such a poor retailer, none of it's competitors who are the ultimate buyers or end users for the locations are going to step up and pay a premium. Target, Costco, et. al. are going to wait for the fire sale. There is no hurry to buy since few retailers are expanding. What mall REIT is going to pay up for a space that needs to be reformatted or substancial TI to be re-tenanted, to say nothing of the releasing risk? A few quarters more of poor operating performance and the short term financing well will dry up. Then comes the fire sale! What if ESL has some liquidations and needs to sell stock to raise cash, where do you think the price will go? I think you can figure out what position I have in this stock. When your longs go wrong sell!
    Reply
  •  
    Aug 14 08:33 PM
    Sears is not where you want to look to invest. America rarely shops Sears. It will be difficult for them to profit.
    Reply
  •  
    Aug 16 01:24 PM
    the reality of bankrupcy...here's some numbers...

    IF THE CONSUMER goes down...who is GONNA SHOP AT SEARS or most retailers for that matter...

    www.abiworld.org/AM/Te...

    flashrob
    Reply
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