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Poor Holiday Puts Sears’ Woes in Spotlight

The retailer endured body blows on the equity and credit fronts Friday following its report of a dismal holiday performance.

Sears Holdings Corp. endured body blows on the equity and credit fronts Friday following its report of a dismal holiday performance.

This story first appeared in the January 13, 2014 issue of WWD.  Subscribe Today.

Moody’s Investors Service pushed the company’s credit rating deeper into speculative territory, downgrading its credit rating to “Caa1” from “B3,” and Sears’ shares hit a 52-week low in midday trading Friday before ending the day down 13.8 percent at $36.71.

Earlier in the day, they went as low as $35.50, their lowest mark since January 2012. Shares peaked at $195.18 on April 17, 2007.

The decline subtracted about $300 million from the holdings of Eddie Lampert, chairman and chief executive officer of Sears and owner of about 48.4 percent of its shares through his ESL Investments hedge fund.

The downgrade and drop followed Sears’ report late Thursday of a 7.4 percent drop in comparable-store sales during the crucial months of November and December, with Sears’ U.S. stores down 9.2 percent and Kmart off 5.7 percent.

Sears now expects a fourth-quarter net loss of between $250 million and $360 million, which would push its net loss for the fiscal year to between $1.3 billion and $1.4 billion.

Adding in losses of $930 million in 2012 and $3.11 billion in 2011, the three-year flood of red ink would total between $5.34 billion and $5.44 billion. Sears turned a $122 million profit in 2010.

“Operating performance for fiscal 2013 is meaningfully weaker than our previous expectations, and we expect negative trends in performance to persist into 2014,” said Scott Tuhy, vice president and senior credit officer of Moody’s. “While Sears noted improved engagement metrics for its Shop Your Way rewards program, Moody’s remains uncertain when these improved engagement metrics will lead to stabilization of operating performance.”

The downgrade of a single notch lowers Sears credit into “very high credit risk” territory from the “high credit risk” family. Moody’s noted that it expects Sears’ cash burn to be approximately $1.2 billion this year and “well above $1 billion” during the fiscal year beginning next month.

Moody’s last changed its rating for Sears in January 2012, lowering it two notches to “B3” from “B1.”

In an interview with WWD, Tuhy said the company “still has time” to right itself. “They own a lot of real estate and they still have Lands’ End. They’re fine in the near term. The first thing they have to do is stabilize sales. Once they know what their stable sales base is, they can begin to plan around it. That’s not a solution, but it would be a good first sign, meaning that they’d reached a kind of floor. Earnings would — or could — move up from there.”

Sears’ domestic comps are down 3.9 percent in the first 11 months of the year, their worst pace since they fell 7.7 percent in 2008 at the start of the Great Recession. Since then, they’ve been down four years in a row, sinking 4.7 percent in 2009, 1.3 percent in 2010, 2.2 percent in 2011 and 2.5 percent in 2012.

By spinning off or selling assets, the company would be improving its cash position at a cost to earnings, Tuhy said. Sears has already initiated efforts to spin off its Lands’ End and Sears Auto Center businesses and to continue to cut unprofitable stores from its fleet of nearly 2,500 full-line and specialty stores.

But while the spin-off of Lands’ End could generate cash, it would also mean sacrificing “well over $100 million” of annual earnings before interest, taxes, depreciation and amortization, according to Tuhy.

“So if they spin it off, it puts more pressure on earnings,” the Moody’s executive said, adding that the capital structure of a spun-off Lands’ End isn’t yet known.

Sears could use its “unencumbered” real estate as collateral for additional financing, as J.C. Penney Co. Inc. did last year, Tuhy noted. It has about $1 billion of cash on its balance sheet, access to $2.3 billion under revolving credit facilities and faces no debt maturities until its $1.8 billion asset-based domestic revolver comes due in April 2016. About $2.24 billion matures in 2018, he added.

Among the more positive data points in Sears’ fourth-quarter update was that its Shop Your Way membership program had grown to account for 69 percent of sales in the first two months of the fourth quarter from 58 percent last year. Tuhy noted that, while the program was still in its early stages, “it’s not helping the results. The initiatives simply haven’t produced material improvements.”

Sears cited declines in consumer electronics at Sears and Kmart this holiday season as well as in tools and home appliances at Sears U.S. stores. It didn’t single out apparel for either a strong or weak performance after citing strength in clothing about a year ago. Tuhy believes that some of the strength in apparel might have been a result of the erosion in Penney’s business throughout 2012.

After buying Kmart out of bankruptcy in 2003 and merging it with Sears in 2004, Lampert transferred ownership of Sears’ Kenmore, Craftsman and DieHard brands to a banktupcy-remote entity that now charges the company royalties to license the brands. Spin-offs of Sears Hometown, the Orchard Supply Hardware stores, the outlet business and, most recently, eight Sears Canada properties over the last two years have also helped to generate sorely needed cash.

But the pace of dealmaking has barely kept up with the pace of sales erosion.

Pam Goodfellow, principal analyst at Prosper Insights & Analytics, noted that, while Sears continues to enjoy a comfortable lead when adults are asked which appliance store they think of first, Lowe’s has made a dent in that margin. And in a sign of further trouble ahead, fewer than one in five in the 18- to 34-year-old category chose it as their preferred destination for appliances, with positive responses dropping 10 percent year-over-year while Lowe’s and Home Depot have grown 26 and 24 percent, respectively.

Brian Sozzi, ceo of Belus Capital Advisors, has been a vocal critic of Sears who’s gone as far as to carry pictures of disheveled-looking stores on his Twitter feed. On Friday, he continued to argue that the company had no choice but to convert valuable assets to cash.

“If they don’t sell assets right now, they could run out of money by holiday 2015,” he told Yahoo Finance.