Sears Holdings on a Downward Spiral

Retailer swings to a net loss of $395 million in Q2 FY16

s1Integrated retailer Sears Holdings Corporation (NASDAQ: SHLD) announced its Q2 FY16 financial results on August 25th, 2016.

The Hoffman Estates, Illinois-based Company is the parent company of Kmart Holding Corp. (Kmart) and Sears, Roebuck and Co. (Sears).

The Company operates through two segments: Kmart and Sears Domestic. It also offers Shop Your Way, a member-based social shopping platform that offers rewards and personalized services. Its brands include Kenmore, Craftsman, and DieHard. It also maintains a range of apparel and home offerings, including labels such as Jaclyn Smith, Joe Boxer, Route 66, Cannon, and Levi’s, and the company also offers Lands’ End merchandise in its Full-line stores. Sears operates about 1,670 Full-line and specialty retail stores in the U.S., operating through Kmart and Sears as well as websites sears.com and kmart.com. Read more about Sears Holdings’ financial results below.

Q2 FY16 financial highlights

Source: Company's Reports
Source: Company’s Reports

During Q2 FY16, Sears’ revenues plunged by $548 million to $5.7 billion compared to $6.2 billion year-ago period. Comparable store sales fell 5.2%, accounting for $240 million of the revenue decline, while fewer Kmart and Sears Full-line stores in operation accounted for $199 million of the revenue decline. In addition, revenues from Sears Hometown and Outlet Stores Inc. also declined by approximately $75 million during the reporting quarter.

Source: Company's Reports
Source: Company’s Reports

During Q2 FY16, Sears’ selling and administrative expenses decreased $210 million compared to the prior year quarter. In addition, advertising expenses declined due to the shift away from traditional advertising to the use of Shop Your Way point expense. During the quarter, gross margin decreased $175 million due to a decline in sales, as well as a decline in the gross margin rate.

Sears narrowed its adjusted EBITDA of $(191) million in Q2 FY16 from $(226) million in the prior year second quarter. In all, the Company swung to a net loss of $395 million in Q2 FY16 compared to net income of $208 million in the prior year period.

Sears’ quarterly earnings, marked by plunging sales and very high levels of unprofitability, lagged behind the slight improvement seen with other department stores such as Kohl’s Corp. (NYSE: KSS), Macy’s Inc. (NYSE: M) and The J.C. Penney Company (NYSE: JCP). Just over a year after selling the majority of its real estate for $2.7 billion, and despite cost-cutting measures, Sears is expected to avail a $300 million loan from ESL Investments to build inventory for the holiday season.

Segmental highlights

s4Kmart: During Q2 FY16, Kmart’s comparable store sales decreased 3.3%, while gross margin rate improved 10 basis points compared to the prior year second quarter. Excluding the impact of significant items, Kmart’s gross margin rate would have declined 10 basis points due to declines in the grocery & household and apparel categories.

Sears Domestic: During Q2 FY16, Sears Domestic’s comparable store sales fell 7%, primarily due to decreases in sales of home appliances, apparel, consumer electronics, footwear, lawn & garden and tools. Sears Domestic’s gross margin rate declined 150 basis points. Excluding the impact of significant items, Sears Domestic’s gross margin rate would have declined 100 basis points compared to the year-ago period, mainly due to a decline in the apparel category. The margin rate in both segments was negatively impacted by increased promotional markdowns, including an increase in Shop Your Way expense.

Other highlights

Cash proceeds: During Q2 FY16, the Company generated cash proceeds of $176 million from the sale of real estate properties and other asset sales. The Company’s cash balances were $276 million as of July 30th, 2016 compared with $238 million as of January 30th, 2016.

Source: Company's Reports
Source: Company’s Reports

Inventory: Merchandise inventories were $4.7 billion as of July 30th, 2016, compared to $5.0 billion as of August 1st, 2015, while merchandise payables were $1.3 billion and $1.7 billion as of July 30th, 2016, and August 1st, 2015, respectively.

Proceeds from assets sale: The sale of assets, combined with the previous closing of the $750 million Term Loan, together with the $500 million Secured Loan Facility, generated over $1.4 billion of financing during H1 FY16. Sears is expected to top this up with $300 million of additional debt financing, for which it received a proposal from ESL in August 2016.

Kmart lawsuit: On August 3rd, 2016, Kmart agreed to pay $5.2 million to settle a lawsuit brought on behalf of hundreds of credit unions and banks over a 2014 data breach. The deal, which needs court approval, also calls for Kmart to improve its data security and train employees to better protect consumers’ credit-card data.

Reduction of rental expense: As a result of the Seritage and JV transactions, Q2 FY16 included additional rental expense of approximately $48 million. However, due to store closure over time, Sears has received recapture notices on 15 properties, which is estimated to reduce rent expenses by approximately $8 million on an annual basis.

Strategic initiatives: On May 26th, 2016, Sears announced its intention to explore alternatives for its Kenmore, Craftsman, and DieHard brands and its Sears Home Services business by evaluating potential partnerships or other transactions that could expand distribution of its brands and service offerings to realize significant growth.

Guidance for FY16

Sears’ ongoing cost cutting measures has improved adjusted EBITDA by $35 million year over year. However, the Company is faced with intense competition in appliance sales and other categories such as home appliances, apparel, and consumer electronics. In the face of a challenging retail environment, Sears expects to generate mid-single digit positive comps in the next few quarters banking on the robust job growth data and wage rises over the past few months.

Stock Performance

s6Sears’ stock ended the day at $13.49, slipping 2.03%, at the close on Thursday, September 2nd, 2016, having vacillated between an intraday high of $14.17 and a low of $13.32 during the session. The stock’s trading volume was at 659,954 for the day. The Company’s market cap was at $1.44 billion as of Thursday’s close.

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