Implications: Fitch lowers Sears Holdings debt rating amidst government backed financial industry bailout. Here's why Sears isn't likely to benefit.
Analysis: What plan? By now it must be clear to all but the most fanatic supporters of Sears that Chairman Ed Lampert doesn't have a plan for either the Sears or Kmart brands. Nowhere is that more evident than in Lampert's recent selection of Michelle Perlman to head the company's jewelry business unit. According to press reports Perlman headed Internet merchandising, marketing, technology, and operations for the high-end lady’s apparel retailer, Ann Taylor.
Now fine jewelry wasn’t a very important category Ann Tailor’s business and it isn't a big business for Sears’ stores either. But it is a profitable one. On average, jewelry represents about 3% of sales of most department store sales. However, fine jewelry margins are usually higher than apparel and several times that of hard lines, so the category can contribute 4% to 6% of a stores gross profit. Using that guideline, Sears and Kmart combined have the potential to do about $1.5 billion in jewelry, about 40% more than current estimates of the company’s fine jewelry sales as of 2006. Simply put, Sears is leaving about $400 million on the counter despite its 4 years of comparable store declines.
That’s a big hunk of cash that should be relatively easy to put in the till, especially since the jewelry category increased about 5% in 2006, significantly out performing company store for store sales. While I suspect that trend has changed, most experienced retail executives would see that as an opportunity to invest in people, inventory, and marketing to service existing in-store demand. But not the Sears’ Chairman, he thinks most retailers are inefficient and adding people, training staff, and extending inventory is wasteful. His solution, grow the jewelry business through the Internet; at least that’s how his strategy stacks up given Perlman’s recent appointment. Unfortunately the numbers don’t really work.
While each firm varies, average Internet sales comprise about 3% of jewelry sales for mid market specialty retail jewelers. In other words, a business doing $1.0 million in jewelry sales could expect to do about $30,000 through a fully developed Internet site. For instance, Zale’s Internet jewelry sales are about $45 million. That’s approximately 2.1% of the company’s annual sales. Applying that formula to Sears, a fully developed Sears/Kmart jewelry site could generate about $20-$30 million in revenue with about half that new growth. That still leaves about $385-$390 million on the counter. Not a very good plan.
Jewelry isn’t a very big part of Sears Holding’s business, so the Chairman can be a little cavalier about how it’s managed. Nevertheless, I think it speaks volumes about how he thinks and also why Sears/Kmart will not survive as retailers under his leadership. Clearly he lacks a vision for the business, but more importantly, he thinks in terms of bazaar solutions that seldom stand the test of scrutiny. Meanwhile, he eschews best practices in retailing, claiming the returns are low, while leaving hundred’s of millions in sales on the counter for the competition to pocket for free.
That should worry share holders, because the company’s real estate holdings are decreasing in value too. Ultimately, that real estate is no more valuable than the revenue that can be generated from the locations. Sadly, for investors, acquiring those assets is becoming a zero sum game for many retailers and developers alike. While some of the space may still have premium values, on the whole demand is declining for that kind of big box space whether in malls or shopping centers. The same can be said for Sears Roebuck’s brands also. With the exception of Lands End, it’s problematic what incremental value Kenmore and Craftsman have in the market place today with out a Sears store to define them.
Neither Sears nor Kmart brands will likely grow again. The biggest benefit to the market would be if they were liquidated. That’s the part of capitalism that no one likes; especially if it’s your friend or family member that looses their job. As far as investors are concerned they have choices. They can both sell their stock now and reinvest the proceeds in any number of emerging values in the market today or they can ride Sears’s price down. If they choose the former, they may have a loss that will in all probability be off set buy a gain on the appreciation of a value purchases now. On the other hand, they can choose the latter and suffer both opportunity loss and real losses too if Lampert’s partners look for a quick exit plan in this volatile market. Realistically, the only thing propping Sears’ stock up today is his partner’s commitment to the deal, but that commitment may be waning as the financial markets implode.
"The important take-away from today is not Treasury Secretary Henry Paulson or Securities and Exchange Commission Chairman Christopher Cox" but that rallies are for selling. That’s what Jim Cramer said on the TV show "Mad Money" Cramer was speaking after the announcement of the government’s plan to orchestrate a $700 billion bailout to buy mortgage backed securities from nearly insolvent financial institutions. Underlying Cramer’s comments is the realization that street has yet to see the size of the write downs these companies will take over the next two years. Taxpayers may be underwriting these institutions’ liquidity, but not their profitability. When the fire sale is over, Uncle Sam will own the industry along with the oversight. Congress will be on the board of every institution that takes the deal and industry lobbyists aren’t likely to change that. Effectively, Cramer is saying stocks are not at their record lows, but their future highs. That would include Sears Holding too.
Why? Because there are only two ways to pay for this bailout, higher taxes and inflated money supply. Both hurt the consumer now and in the future too. Effectively the bailout at best amortizes Wall Street’s institutional losses over the next decade, hurting the profitability of all businesses that depend on increased consumer spending to grow profitability like Sears.
Whether Sears’ shareholders will follow Cramer’s advice remains to be seen, but debt rating institutions appear to be losing faith in Lampert’s voodoo retailing. According to Thompson Financial, Fitch Ratings downgraded Sears Holdings from BB to B+. That’s a big change in how the financial markets perceive Sears and that should concern investorsvestors also. Effectively the debt markets no longer believe Sears’ problems will necessarily reverse themselves as the economy improves. They see the business as more volatile today because of its leadership saying, “In addition, the longer term retail strategy remains unclear, particularly given the announced changes to Holdings’ organizational structure earlier this year, which could lead to operational disruption in the near term.
Luxury Retailers may be a solid long term play