This Retailer has a Lot of Work to Do

By Chad Henage - August 30, 2012 | Tickers: AMZN, KSS, SHLD, TGT, WMT | 0 Comments

• Email
• Print

There might not be a better example of a retailer that has missed consumer's preferences more clearly than Sears Holdings (NASDAQ: SHLD). With analysts calling for the company's earnings to get worse between 2012 and 2013, if the company is going to turn around, there are a few steps that need to be taken as soon as possible. Investors can clearly see the challenges that the company faces by looking at the most recent earnings report.

The Results aren't Pretty

With overall revenues down 7.6%, and a loss from continuing operations, there is no question this retail conglomerate has its challenges. The company's Sears Domestic division saw comparable sales down 2.9% and the company was directly affected in my opinion by Amazon.com (NASDAQ: AMZN) and their aggressive pricing in the consumer electronics space. The company all but admitted this issue by saying they saw “pricing pressures” in consumer electronics. In addition, Sears blamed drought conditions for the negative impact on sales in their lawn and garden centers. The company's challenges also extended to both Sears Canada and their Kmart division. In the Canadian division, comparable sales decreased 7.1%, while at Kmart comparable sales were down 4.7%. Any time a retailer with three divisions show significant declines in comparable sales at all three, investors are not going to be happy. That being said, there are a few things I've noticed about the company's financial performance that Sears could change to improve in the future.

What is Going on at Sears Domestic?

One concern about the company is their cash versus debt position. With $738 million in cash and the transaction for their Sears Hometown and Outlet Stores expected to raise $446.5 million, at least in the short-term the company should be okay. The main thing that Sears could do to improve their performance going forward is, to take a hard look at their selling general and administrative expenses at each business. There seems to be a disconnect in this line item between Kmart and Sears Domestic and Canadian units. Take a look at the difference in the SG&A cost per store at each of the company's units:

It seems clear that at the company's largest operation (Sears Domestic), SG&A expenses have gotten somewhat out of hand. When you consider that the cost per store is almost $100,000 more at the domestic division versus Sears Canada or Kmart, it would seem that cost savings are possible. In addition, the company needs to take a hard look at their gross margins and adjust their product mix.

Kmart Needs to Re-Evaluate What They Sell:

Sears faces many competitors, but the two primary competitors to their Kmart division are Wal-Mart (NYSE: WMT) and Target (NYSE: TGT). When you consider that Kmart's gross margin is just 23.4%, versus 24.63% at Wal-Mart and over 31% at Target, clearly something is wrong. What this tells me is Kmart likely needs to re-evaluate their merchandise selection, and choose higher margin, but higher quality goods for their stores. In addition, I honestly never believed that the combination of Kmart and Sears was a great idea. There seems to be little overlap and clearly the cost savings that were envisioned have not been realized. I would suggest the company look at splitting these two divisions back into separate retailers so that they can compete more effectively.

Lands End – Expand it and Make it Cheaper

Where Sears is concerned, the Sears Domestic division reported an almost 29% gross margin which was similar to the 28.3% gross margin at Sears Canada. This is yet another case where the company needs to decide where its strengths lie. Sears is well known for its lawn and garden, tool selection, and appliance sales. While the company has improved its clothing selection, more work is needed. In the clothing area specifically, both Target, and Kohl's (NYSE: KSS) seem to offer a better value to their customers than Sears. When you consider that both of these companies maintain gross margins well above 30%, and both offer significant clothing options, Sears is missing an opportunity.

The Sears brand Lands End is both well known and well respected as a quality clothing line. Sears is missing the opportunity to position this clothing line's pricing appropriately. Lands End makes great quality clothing, but it is expensive. I believe the company would be better served to bring the average price point for Lands End down closer to mainstream pricing. While at first it seems that this would hurt the company's margins, it actually could have the opposite effect. The quality and name brand attractiveness of Lands End at a more attractive price point, could drive significantly higher clothing sales at Sears stores. In fact, the company would be well served to expand the offerings of this clothing line to a larger portion of each of their locations. This would allow the company to compete more effectively in quality clothing with other retailers, and make the stores more of a destination clothing shop.

This Needs to Happen Yesterday

In conclusion, Sears Holdings has a relatively short window in which they can make positive changes to their business model. Changing their offerings at both Kmart and Sears is the first step, and separating the two brands would seem to go along with this idea. Unless the company makes significant changes, sales will continue to decline as customers choose the better relative value that their competition offers. With Amazon.com stealing sales from their consumer electronics division, and companies like Kohl's and Target stealing sales from their clothing lines, the company is being squeezed at both ends. At this point, Sears Holdings is best described as a potential turnaround and investors should be aware of the extreme risks involved. The steps to become relevant again can't happen soon enough.

• Email
• Print
• Feedback