SEARS STOCK TAKES HIT AS CREDIT CARD WOES ALTER HOLIDAY OUTLOOK

Byline: Thomas J. Ryan

NEW YORK — Third-quarter net rose 7.9 percent at Sears, Roebuck & Co. but growing delinquencies in the giant retailer’s credit card business would probably cause it to miss its ambitious earnings goal of mid-teen percentage growth for the fourth quarter, the company said Thursday.
Shares of Sears slid 5 13/16 to 48 1/16. Trading volume hit 13.7 million shares, making Sears the third most-active stock on the New York Stock Exchange. The company’s daily trading volume is 1.3 million shares. The results not only revealed continuing problems in Sears’ credit card business, which had been its cash cow for years, but also suggested other retailers might report that they, too, experienced difficult third quarters. Sears reports about a month ahead of most retailers since it operates on a calendar year, rather than a fiscal year.
Sears’ domestic retail business posted flattish earnings in the quarter due to soft sales and increased charge-offs in its credit card business. The overall profit improvement was tied to solid profit gains generated by Sears Canada, home services and direct response businesses.
In the quarter ended Sept. 27, earnings from continuing operations rose to $301 million, or 76 cents a share, from $279 million, or 68 cents, a year ago. Results beat Wall Street’s average estimate by a penny.
Sales climbed 8.4 percent to $9.83 billion from $9.07 billion.
“While we are relatively pleased with Sears’ performance year-to-date, as we enter the fourth quarter we are concerned about the adverse trends in our credit card business,” said Arthur Martinez, Sears chairman and chief executive officer, in a statement. “As a result, it is unlikely we will be able to achieve our goal of mid-teens earnings growth in the fourth quarter of 1997.”
Martinez noted that Sears continues to experience increased rates of delinquencies and charge-offs “while a number of other credit card issuers have recently reported flattening in their charge-off rates.”
He added, “If our delinquency and charge-off trends continue, the resulting increases in the provision for uncollectible accounts could have a significant adverse effect on the company’s overall operating results in future periods. We are taking steps to mitigate the effect of these trends on earnings and are assessing their expected magnitude and direction.”
Joseph C. Ronning, at Brown Bros. Harriman, said that although the credit card situation was “a major disaster,” the weakness in Sears’ retail business was also disappointing.
Ronning said taking out the profit gains in the credit business and home services, profits at the full-line stores were down. While electronics and appliances “did very well,” a shift away from apparel items, which carry higher margins, hurt overall margins.
Ronning said the unusually warm weather in late September and early October hurt not only Sears’ full-line business, but most retailers, and analysts have been trimming their estimates on many firms.
“It will be really interesting to see if this recent colder weather we’re getting will spark sales,” Ronning added.
Some economists are also concerned about increasing consumer debt. As Carl Steidtmann, chief economist for Management Horizons, said Wednesday when asked about the dismal September sales seen across the country, “I think the real reason that sales are lousy has to do with the state of consumer finances, which aren’t all that great. Consumer credit debt is at record levels, with much of it falling most heavily on middle income households.”
Prompted by the credit card difficulties, NatWest Securities dropped its rating on Sears’ stock to “hold” from “accumulate,” and Lazard Freres cut its rating to “hold” from “buy.”
Domestic provision for uncollectible accounts surged 85.2 percent in the quarter to $503 million, excluding a change in accounting for credit card securitization. Sears blamed the increase on a continuing trend in delinquencies and bankruptcies, growth in credit card receivables portfolio and a lower rate of reaffirmations.
The provision includes a $40 million hike in bad debt reserve. Including the accounting change, the provision increased 44.6 percent to $393 million.
As reported, Sears took a $320 million write-off in the second quarter to cover claims arising from the failure to file reaffirmations of obligations by bankrupt customers.
Domestic credit card revenues gained 18.6 percent in the quarter, to $1.32 billion as a result of higher receivable balances and increased late fees as new pricing initiatives took effect, partially offset by the change in accounting for credit cards.
Sears held a conference call with analysts Thursday, but according to analysts, Sears executives did not provide a clear prognosis for the fourth quarter and year ahead due to the credit card situation.
Lazard Freres analyst Todd Slater cited Sears’ “inability to quantify or at least provide a range for fourth-quarter earnings and beyond” and added, “That may be what’s spooking some investors.”
“I was hoping that the credit card issue would go away,” said Robert Buchanan, an analyst at NatWest Securities. “But with the sizable increase in the bad debt provisions, it now appears that substantial improvement is a way off.”
NatWest lowered its earnings estimate for the fourth quarter by 17 cents a share to $1.35, against $1.42 earned last year. For the year, Buchanan cut his estimate by 14 cents to $3.49 and by 38 cents in 1998 to $3.65. In 1996, Sears earned $3.12.
Buchanan also said the sizable hike in bad debt provision shows that “clearly, it’s a big problem, and we’re not getting a lot of answers at this time.”
Buchanan said he doesn’t expect Sears noncredit business will be “sufficiently strong to fully offset” the problems in the credit area, noting that men’s, children’s and home goods all lagged in the quarter. Women’s was “better,” with strength in the Crossroads casual line and Apostrophe and First Issue career wear line.
Martinez added that the firm’s retail business at the start of the holiday season was “well positioned to provide our customers with the right merchandise mix, in-stock levels and service, supported by the strongest advertising and merchandising program in our company’s history.”
Excluding special items, earnings from domestic operations nudged up 0.7 percent to $294 million from $292 million. Domestic sales climbed 9.1 percent to $9.04 billion from $8.28 billion.
Domestic retail revenues climbed 7.7 percent to 7.8 billion. Same-store sales increased 2.2 percent which was below Sears’ plan for mid-single-digit gains.
Martinez said the domestic retail sales increases “were below plan levels due largely to unseasonal weather.”
Sales were aided by the addition of five full-line stores and 41 off-the-mall auto, hardware and furniture stores. As of Sept. 27, Sears had 826 full-line stores and 2,591 off-the-mall units.
Domestic gross margins eroded to 25.8 percent of sales from 26.1 percent principally due to a charge to convert its Western Auto format to Parts America. Excluding the charge, margins “declined slightly,” Sears said.
Selling, general and administrative (SG&A) expenses improved to 19.9 percent of sales from 20.9 percent, largely due to the change in retirement benefits and accounting for credit cards. Excluding these items, SG&A was 20.5 percent of sales.
A bright spot was Sears Canada, which posted a profit of $7 million versus a $13 million loss. The improvement was linked to strong revenue growth and substantial gains in gross margins. Sears owns 55 percent of Sears Canada. For the year to date, Sears International division cut its loss to $34 million from $41 million, with the latest period including a $36 million charge from the sale of Sears Mexico.
“We are extremely pleased with the performance of Sears Canada which, due to its past cost-cutting initiatives, is well positioned to convert revenue increases to the bottom line,” Martinez said.
A barrage of special items in the quarter lifted net earnings in the quarter to $353 million, or 89 cents a share.
In the nine months, earnings from continuing operations rose 16.4 percent to $791 million, or $1.99, from $704 million, or $1.71, a year ago. Net earnings in the latest nine months were cut to $652 million after a $320 million charge for the reaffirmations.
Sales in the nine months gained 8.1 percent to $28.3 billion from $26.2 billion. U.S. earnings excluding charges gained 6 percent to $789 million from $745 million. Nine-month revenues in U.S. operations climbed 8.6 percent to $25.98 billion from $23.93 billion.

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