Don't Gamble On This Turnaround Candidate

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Sears Holdings (NASDAQ: SHLD) is one of the largest retailers in the U.S. with over 2,000 stores under its Sears and Kmart brands, and another 500 stores in Canada.  Sears has been a stock that has disappointed me for some time now, as revenues keep falling (see below) and the company has not quite figured out a way to turn things around yet.  With the company set to report year-end earnings Feb 28, is a turnaround finally on the horizon, or are more declines coming soon?

 

Sears has tried all kinds of techniques to build up their business, such as their Shop Your Way Rewards and layaway programs.  The Shop Your Way Rewards program works sort of like a frequent-flyer program, where shoppers earn points for their purchases that will earn them future discounts. 

Another technique Sears has used to try to make more efficient use of their space is to lease space within their existing stores, such as having an outside business operate a garden department adjacent to the store, or using inside space to create a “store-in-store” setup.  For example, Western Athletic Clubs opened a health club in a Sears in Cupertino, California.  There is also a specialty grocery store in a Kmart in San Diego.

While the company has maintained an online presence for several years, they are now attempting to compete with Amazon.com (NASDAQ: AMZN) by offering third parties access to sell items through their website through Sears Commerce Services.  In my personal opinion, this is a severe misallocation of Sears Holdings’ resources.  This is akin to opening a small electronics retailer next to a long established Best Buy and selling the same products for more money.

Sears just does not have the resources to compete with a giant like this.  Even for items that Sears is known for, such as appliances, Amazon simply has the economies of scale and low overhead needed to undercut anyone else.  For example, I need a new washing machine.  A quick search on Sears reveals that their most popular model is the LG model WM3470HWA which they sell for $1099.99.  I can either pay $69.99 to have it delivered or pick up in store for free.  A few clicks of the mouse later on Amazon and I can have the exact same model for $50 less plus free delivery, saving me a total of $120. 

Sorry to rant so long about Amazon.  Sears is not the first company to make fruitless attempts to compete with Amazon and certainly will not be the last.  The bottom line: If you are bullish on online retail, Amazon is the only winner in this sector (aside from very specialized retailers that sell unique products); however I don’t like Amazon as an investment.  I have written several times about how overvalued Amazon is and how its current value is not sustainable, despite them being the best at what they do.

Sears Holdings’ CEO Lou D’Ambrosio recently stepped down, and Chairman of the Board Edward Lampert took over.  I view this as added uncertainty.  The turnaround finally began to gain traction in fiscal year 2013, which just ended January 31, with closures of over 100 underperforming stores and the spinoff of the Sears Outlet business.  I think the leadership change amplifies the already high level of risk here.

Sears Holdings is not profitable right now, nor are they forecast to return to profitability anytime soon, which makes a usual valuation analysis meaningless.  The company lost $4.69 per share for fiscal year 2012 and is projected to announce losses of $2.28 for FY 2013.  Looking forward, the consensus calls for losses of $3.31 and $2.33 per share in 2014 and 2015, respectively.  With numbers like these, Sears works as a purely speculative play.

Instead, if an investor wants to get retail exposure, there are many better ways to play the sector.  Kohl’s (NYSE: KSS), for example, is a consistently profitable company that trades for 11.2 times current fiscal year earnings, and are projected to have a forward earnings growth rate of over 10%.  Also, investors are paid a nice 2.76% dividend yield while they wait for growth.

Another good play on the sector is Nordstrom (NYSE: JWN), which trades at a higher valuation of 15.9 times earnings, however is projected to grow its earnings by 13.1% and 13.9% over the next two years. Nordstrom has done the best of these department stores in terms of setting up a formidable online presence.  They actually have a shared inventory platform set up, where nordstrom.com orders can be fulfilled from any of the company's 221 stores.  This unique setup has led to perhaps the best inventory turnover rate in the sector, which should help margins going forward.

Either of these two names are a great way to get some specialty retail exposure in your portfolio, without taking on unnecessary risks associated with a yet-to-turn-around company such as Sears Holdings.  As far as Sears goes, I think it may actually be too expensive at current levels and I would wait for a considerable dip in the share price before taking a chance on this one.


KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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