Liquidity concerns are starting to pile up for Sears Holdings Corp.
This story first appeared in the January 13, 2012 issue of WWD. Subscribe Today.
While no other factors have followed the lead of CIT, which has decided to no longer approve orders for Sears Holdings’ vendors, there are concerns that they may eventually decide to follow suit.
In a statement from Sears Holdings, the company said it “disagree[d] with [CIT’s] action, in fact we’d point out that other factors are approving shipments to Sears Holdings and CIT’s payables represented less than 5 percent of inventories. And as we announced last month, we’re going to implement a series of actions to reduce ongoing expenses, adjust our asset base and accelerate the transformation of our business model. These actions include closing between 100 and 120 stores, reducing inventory, reducing fixed costs by up to $200 million and improving gross profit dollars through better inventory management and more targeted pricing and promotion.”
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It’s hard to ignore the question of whether Sears can continue its restructuring and have enough product on the shelves for its two nameplates, Sears and Kmart. For now, the consensus is that it should — because Sears has enough liquidity on hand to pay vendors for orders shipped. Moreover, many of its goods are private label, which are not factored. One example is Lands’ End apparel at Sears and another is its Jaclyn Smith label at Kmart.
Should the noose grow tighter, companies will have to decide whether to continue shipping and take the risk of nonpayment on their own balance sheets if vendor financing shrinks.
As for liquidity concerns, Sears said, “It’s important to note that Sears Holdings has more than adequate liquidity and ample resources at our disposal which give us significant financial flexibility and equally important is to separate disappointing operating performance with liquidity. At the end of December, we had about $4.2 billion of liquidity (cash balances of roughly $0.9 billion and availability on our facilities of approximately $3.3 billion). We fully paid all borrowings on our domestic revolving credit facility during the last week of December, ending the month with minimal borrowings of $90 million and $621 million of letters of credit outstanding, resulting in availability of over $2.5 billion on our domestic credit facility and $800 million on our Sears Canada facility.”
Ratings agency Fitch Ratings said Thursday it “regards CIT Group’s decision to discontinue vendor financing for Sears Holdings as an additional liquidity concern for the retailer in 2012, potentially boosting working capital requirements.…The CIT decision, while affecting less than 5 percent of Sears’ outstanding inventory (5 percent would equate to $400 million to $450 million based on Fitch’s 2012 inventory forecasts), reduces the company’s margin of safety with respect to cash needs as the company looks to avoid further erosion of EBITDA with comp sales under significant pressure.”
Sears also boasted that, in addition to its liquidity, “Sears Holdings is an asset-rich enterprise with inventory that historically has been between $8 billion and $10 billion, market-leading proprietary brands and a substantial real estate portfolio.”
Typically, those assets don’t guarantee short-term liquidity, at least not on a monthly cash-flow basis, but they might provide some form of asset recovery to creditors in a bankruptcy.
Fitch estimated that Sears would “need to generate EBITDA of $1.2 billion to $1.3 billion annually in 2012 and 2013 to service cash interest expense ($260 million to $280 million), capital expenditures ($400 million), and contribution to pension plans ($300 million) and debt maturities.” With less than $400 million in EBITDA expected for 2011 and the potential for EBITDA to turn negative in 2012, the ratings agency concluded that operations will have to be funded with increased borrowings on its revolvers, with additional external financing required in 2013, if not earlier.
One real estate source is already anticipating another round of store closures at Sears Holdings, on top of the 100 to 120 sites it said it would shutter late last month. Another industry source speculated that Sears could possibly close more Sears stores and fewer Kmart sites. That’s because each merchandising department gets charged back a rental fee for the space that department occupies in the stores. Even if a department does well, it’ll show less profitability after it gets nickel-and-dimed for its share of occupancy costs.
And operating profitability for the merchandising departments could look better for Kmart stores than Sears locations. Currently, Sears charges higher fees than its sibling Kmart, which is primarily freestanding-based stores, said one source with knowledge of the retailer’s operations. The source implied that there are higher operating costs surrounding the mall-based Sears stores. An additional contact who works on the operations side of retail said this practice was atypical among retailers, and noted that it seems unique with Sears Holdings.
James W. Harris, president and founder of Seneca Financial Group, said, “Kmart and Sears are having a tough go of it right now because they are caught between discounters and the Internet. Both brands have lost their way from being true discounters to mass marketers and that category is very uncompetitive with the Internet at the time. Neither brand has an Internet strategy that is effective.”
Harris was also critical of hedge fund operator Edward S. Lampert, who is chairman of Sears Holdings: “He does not understand merchandising although he thinks he is a genius at it. He has a weak management team. He believes he can harvest billions from his investment through the liquidation of real estate assets over time. This is subject to differing opinions given the nature of the assets and the state of the commercial real estate market today.”
Lampert continues to build his investment in Sears. Earlier this week he purchased more Sears shares, about 4.9 million shares for around $142.5 million at an average price range of $29.50, according to a regulatory filing with the Securities and Exchange Commission Wednesday. Lampert has been acquiring a bigger stake in Sears, both on the open market and through shares sold by his hedge fund ESL Investments that he in turn acquired for his personal holdings in the retailer.
Shares of Sears closed at $34, up $1.10 or 3.3 percent, in over-the-counter trading Thursday.