Sears' Investors Face Certain Loss.

Implications: Years of sales declines and current operational loses, probably means Sears can't be saved.  Here's why. 

Analysis: I am not sure Sears lost out to Costco as much as it’s just a looser, at least under its current management.  Sears Holdings the result of the merger of Sears Roebuck and Kmart hasn’t had a comparable store sales increase since the deal in 2005.  Granted the holding company generated significant earnings and cash in the beginning.  But that was a consequence of one time gains from the consolidation of the two companies.  Two years later, the company is losing money.  

First billed as a real estate play and as a hedge fund gambit where Sears’ huge cash flow would be invested in growth businesses, neither materialized.  Most of the excess cash was diverted to overpriced stock buy backs and system improvements which were supposed to increase the retail stores efficiency.   That’s a polite way to say the investment in systems was to be paid for by termination and early retirement of most of Sears’ higher paid, experienced field personnel.  

Unfortunately, that’s about the only thing hedge fund manager and holding company chairman accomplished during his disastrous two years as Sears’s chief strategists.  In retrospect, his actions were tantamount to the same thing Circuit City executives were accused of when they arbitrarily fired their most experienced, higher paid employees.  Now Sears’s probably has by far the worst field organization in the retailing industry. 

The HR factor in retailing has plagued ‘big box’ store operators for several decades.  Department stores have been moderately successful in eliminating sales staff, while shifting the stores to a self service environment.  With the exception of a select few brands like Saks or Neiman Marcus, it’s not uncommon to have entire departments in serviced by one employee, while anxious customers search for someone to take their money.  Macys’ is even experimenting with selling branded, personal electronics through a vending machine; anything to eliminate the human factor in retailing.   

While Sears’s hasn’t reduced its store offer to the level of vending machines, at least not yet, the stores are seriously understaffed and untrained.  In a business that historically specializes in products like tools, auto parts and repair, home improvement, electronics, appliance, and fine jewelry, Sears’ current employees are woefully ignorant about both the categories in general and the product in particular.   

Part of the problem is too few hours allocated to cover the various departments.  But the lack of training is equally disturbing.  Some department managers complain about sales associates that can’t operate the POS systems.  Others say turn over among new hires is so high that it’s impossible to fill the meager hours available to staff the store.  

Management turnover is also rampant.  New managers are frequently heard to tell frustrated customers that they are new and just don’t know how to function in the jewelry, appliance, automotive, or tool departments.   One co-store manager told the frustrated jewelry department manager that he had transferred from Kmart and that jewelry wasn’t a priority.  It’s not surprising jewelry sales may have declined by as much as 30% since the merger.   

In the current economy, Sears may have a problem with its product offer.  It certainly has problems with its breadth of assortment in its specialty departments and apparel branding.  But those problems might be fixed by a skilled merchant. The more difficult problem to repair is the broken field organization.  Sears has now lost most of its reservoir of knowledgeable and experienced managers and sales associates.  They can take years to replace, if they can be replaced at all. 

In a company that where more than half of its revenue is from the sales of specialty goods, such a loss is catastrophe which current sales declines and operating losses are just beginning to reflect.  Even if the economy rebounded to its 2005-2006 levels, it’s problematic whether Sears could ever compete against its much stronger specialty competitors because of the collapse of its field organization.  

Given the company’s history of declining sales since the merger and its current trend in operating losses, Sears has probably moved from the category of a ‘risky turnaround’ to likely ‘financial workout’. Selling near its 52 week low of $82.59, the market has begun to recognize the decline in the company’s core enterprise value.  Probably, more important is Sears Holding’s book value.  It’s currently about $80.08 per share.  Today, that’s brackets the company’s market and break up value at about between $10.9 and $10.6 billion. 

Those numbers are likely to decline more as Sears racks up larger and larger operating losses.  So should shareholders ride the stock down further, hoping the pieces can be sold off for more than its core value declines or sell now?  In part, that’s depends on your investment horizon and whether your one of the top 5% owners of Sears Holding which hold about 76% of the stock. 

Certainly, you don’t want to be long in the stock if the five big institutional investors start selling.  On the other hand, keeping the stock means you think there is a high probability the stock will appreciate over the next 6 to 12 months.  That means sales increases Christmas 2008 or substantial asset sales above book value of real estate and/or brands in the interim.  In any event, the only thing that seems certain is there are probably no winners in this tragedy, only those that lose a lot and those that lose lot less.