Sears Shares Fall Despite Potential Asset Sale

A sale of part or all of Sears Canada would be the last cash-generating tactic by Edward Lampert to shore up the retailer’s weakening balance sheet.

The pressure continues to grow on Edward Lampert.

This story first appeared in the May 15, 2014 issue of WWD.  Subscribe Today.

Shares of Lampert’s Sears Holdings Corp. fell 5.85 percent on Wednesday following the retailer’s news that it has retained an investment bank to explore strategic alternatives for its 51 percent stake in Sears Canada, or the sale of the Canadian operation as a whole.

Sears’ shares fell $2.53 on Wednesday to close at $40.70.

A sale of part or all of Sears Canada would be the last cash-generating tactic by Lampert to shore up the retailer’s weakening balance sheet. Such a sale would follow the recent spin-off of Lands’ End, the disposal of  numerous real estate assets and the divestiture of subsidiaries including Orchard Supply and Hometown Outlet.

Sears’ free cash flow has been negative for the last four years, with an outflow of $1.44 million. At this rate, experts believe Sears will burn through its cash in less than a year.

“The noose is tightening in terms of what they have left that they can do,” said Matt McGinley, an analyst at ISI, referring to Sears’ assets. “I don’t think 2014 will be different in terms of operating cash burn. Sure, they’ll find some other things to sell or spin off if they can, but the number of options is limited.”

Sears is perpetuating a cycle of decline, McGinley said, noting that the retailer continues to lose sales every year. In its attempt to return to profitability, it cuts SGA costs, which largely consists of payroll and advertising expenses. Sears spends about $300 million a year on capital expenditures, less than $1 per square foot on stores. By comparison, other retailers spend $5 to $10 a square foot just to maintain their stores. “Most of these locations have been neglected for so long. A poor shopping experience leads to less foot traffic. It becomes a vicious cycle,” he said.

Mary Ross Gilbert, an analyst at Imperial Capital, said Sears Holdings a year ago was “planning to do something with Sears Canada. Over the last few years, they talked about considering monetizing some of these investments. It could include a sale of their stake or a sale of Sears Canada as a whole. They went through a similar process with Lands’ End. It seemed like they couldn’t get the deal they wanted, so they spun it off.”

Sears Canada has slowly been divesting of some of its stores. In November, the retailer sold its 50 percent stake in eight properties in a deal valued at $315 million. Sears Canada previously sold the lease to its flagship in the Toronto Eaton Centre and four other leases for $400 million.

Sears Canada has three locations left that are joint investments with a smaller stake of 15 percent to 20 percent. “We were valuing those three stores at $43 million,” Gilbert said.

Sears is also evaluating its strategic position with its Auto Center, which was valued in 2013 at $666 million. About a year ago, Sears talked about monetizing its Protection Agreement service, a warranty business, which is reportedly profitable. Nothing has been said about the warranty business since, leading some observers to the conclusion that Sears wasn’t able to structure a deal to its liking.

Sears reported a net loss in the fourth quarter of $358 million, or $3.37 a diluted share, for the three months ended Feb. 1, below the loss of $489 million, or $4.61, a year ago. Revenues decreased 13.6 percent to $10.59 billion from $12.26 billion. Comparable-store sales fell 6.4 percent, reflecting a 5.1 percent decline at Kmart and a 7.8 percent drop at Sears’ domestic stores.

For the year, the loss extended to $1.37 billion, or $12.87 a share, from a loss of $930 million, or $8.78, in 2012. Revenues fell 9.2 percent to $36.19 billion from $39.85 billion.

Last year, sales of Sears Canada totaled $3.8 billion out of the company’s total merchandise and services revenues of $36.19 billion. The Canadian operation has a higher concentration of apparel and soft home goods than its U.S. counterparts. In 2013, those categories accounted for 49.2 percent of Canadian revenues, or about $1.87 billion.

Keith Howlett, a retail analyst at Desjardins in Toronto, said Sears Canada has about $500 million in cash on its balance sheet, of which half would go to Sears Holdings.

Howlett said potential buyers include pension funds or mall owners who want to reposition their properties — Sears Canada stores are generally in better locations than their American counterparts. “They tend to be in every good mall in Canada,” Howlett said. In addition, turnaround companies such as Sun Capital, Hilco and Gordon Brothers may be interested, along with private equity groups. Retailers such as Wal-Mart Stores Inc. or Hudson’s Bay Co. could look at the real estate, although the latter appears to have its plate full with Saks Fifth Avenue, Lord & Taylor and Hudson’s Bay. However, it might want to purchase the properties as a preemptive strike to thwart competition. “There’s been some discussion as to whether Macy’s would be interested in entering Canada, or Kohl’s, which has looked at Canada,” Howlett said. “Wal-Mart has 380 stores here and has gotten into some pretty good malls. Target would look at some of the stores.”

“[Sears] has significant operating loses they need to fund with asset sales,” McGinley said. “As far as the type of buyer, it’s not too long of a list. They’ll get plenty of lookers but not too many bidders.” The fact that Canada is a difficult retail environment will discourage some chains.

“Private equity shops may want it at a reasonable price,” McGinley said. “Some retailers might want to look at it. But it’s relatively unlikely that they would find a buyer for the entire asset. In six months or a year,  they will likely spin out the remaining 50 percent.”

Moody’s Investment Service said divesting of Sears Canada is “considered a credit positive for Sears Holdings as this transaction, if concluded, could generate significant cash proceeds that would help to offset the expected cash burn for the company in 2014.” Moody’s said there’s no impact on the company’s rating.