Byline: Thomas J. Ryan

NEW YORK — The softer side of Sears is simply too soft.
Sears, Roebuck & Co. reported that, hampered by declines across all apparel lines, operating earnings in its retail group nudged up only 2.3 percent in the third quarter ended Sept. 30. It also warned that fourth-quarter earnings may decline because of difficult comparisons in its highly profitable credit card segment. Wall Street said credit weakness was unlikely to be offset by the retail segment because of poor apparel trends.
For the fourth quarter, Wall Street was looking for $2.04 a share, up from $1.98 a year ago. Shares of Sears Thursday fell $2.34, or 7 percent, to $30.86 on the New York Stock Exchange.
Driven by the credit card, Sears reported third-quarter earnings jumped 17.8 percent to $278 million from $236 million a year ago. Excluding a charge of $29 million in the prior year to cover staff reductions and the exit of some automotive units, earnings were up 4.9 percent.
Earnings per share jumped 30.6 percent to 81 cents a share from 62 cents as repurchases reduced average shares outstanding to 341.8 million from 381.5 million Wall Street’s con381.5 million. Wall Street’s consensus estimate was 80 cents.
Total revenues climbed 4.7 percent to $9.63 billion from $9.2 billion.
Alan J. Lacy, who became president and chief executive in September, said results were driven by “very strong growth” in credit card income, while strength in hardlines offset declines in apparel at its 860-unit full-line stores. “Consistent with general industry trends, our softlines business has been challenging and has had an unfavorable impact on our gross margins,” Lacy said on a conference call.
In the retail group, operating income before nonrecurring items rose slightly to $44 million from $43 million. Sales ran ahead 5.3 percent to $6.9 billion, with domestic same-store sales ahead 3.5 percent.
The sales gains were led by mid to high single-digit gains in appliances, electronics, lawn and garden and sporting goods. Men’s and children’s apparel declined and was “challenging” while women’s was “essentially flat,” as declines in its core apparel lines were offset by strength in fine jewelry, cosmetics and fragrances. Home fashions and footwear increased.
Greater markdowns in apparel — both domestically and in its Canadian operations — caused gross margins to erode to 25.6 percent of merchandise sales from 26.5 percent a year ago. Margins were also hurt by the increased portion of hardline sales, which carry lower margins.
The star was credit, with operating earnings climbing 21.8 percent to $385 million, largely due to substantial reductions in selling and administrative expenses. Credit revenues climbed 1.4 percent to $999 million.
“Their credit business really drove earnings in the third quarter,” said Wayne Hood at Prudential Securities. “The retail side was driven by strength in major appliances and electronics. But as a result of the weakness in apparel, they had higher-than-expected markdowns, and that put pressure on margins.”
Lacy said earnings may decline in the fourth quarter partly because the 1999 fourth quarter was boosted by a $103 million LIFO (last-in first-out) credit. He noted that it “may not be appropriate” to expect similar results this year.
The year-ago period also included a surprisingly strong 30 percent decrease in the company’s provision for uncollectible credit card accounts. Sears is expecting this provision to increase this year because the launch of the Sears-branded Mastercard in July has increased its credit card portfolio, said Lacy. “We expect that credit operating income will be down year-over-year in the fourth quarter,” said Lacy.
“We continue to plan full-year EPS growth in the low- to mid-teen range,” he said. “Given our strong performance year-to-date, this implies the potential for a down fourth quarter.” But Lacy was fairly confident about prospects for the retail segment, and noted that the stores will be carrying a “much more impactful promotional calendar” compared with last year, when Sears reduced a number of unprofitable holiday promotions to shore up margins. Lacy said the stores should feature better “shopability” with many adding centralized cash wraps, shopping carts and improved signage.
In particular, Lacy pointed to the opportunity to gain market share in appliances given Circuit City’s exit from that category, heightened interest in digital products and strength in tires resulting from the Firestone recall.
Indeed, inventories at the end of the quarter were up a sizeable 12.5 percent to $6.3 billion from $5.6 billion to support investments in its strong hardlines categories.
“We have made the conscious decision to chase some of the opportunity we see,” said Lacy.
But, Sears is playing it safer in apparel — only $60 million of the increase was tied to wearing apparel. Inventories in ready-to-wear and children’s are down from last year’s levels.
While noting that markdown pressures crimped apparel results in the third quarter, Lacy said Sears hasn’t altered its holiday apparel plans. “We anticipate it’s going to be a very competitive season,” said Lacy. “But we do feel that there’s nothing that’s going to change our guidance on what we see in the business.”
Steve Kernkraut at Bear Stearns said that, given the weakness in credit, Sears will be counting “much more on apparel to be carrying the ball. They’ve got to have apparel make a strong contribution in the fourth quarter and 2001.”
One major advantage for Sears is that, despite concerns over competition from Home Depot and Wal-Mart, hardlines continue to be strong for Sears, Hood said. The apparel weakness seems to be industrywide. Sears is responding to market research to improve its apparel presentation, including reducing clutter in the stores to make them easier to shop, partly by cutting back its vendor list, Hood said.
Hood said apparel may improve in the fourth quarter given the better trends at retail seen in the the last 30 to 40 days, as fall shipments hit the stores.
But Kernkraut said Sears’ progress in stimulating apparel sales will be tough in the current retail climate.
“The consumer is somewhat concerned about oil prices and concerned about what’s happening in the stock market, and they’re slowing their spending,” Kernkraut said. “It will be a frenzied shopping environment and probably be more promotional than last year.”
In the nine months, net earnings climbed 26.4 percent to $901 million, or $2.57 a share, from $713 million, or $1.86, a year ago. Retail earnings before nonrecurring items surged 61.2 percent to $237 million, while sales gained 4.2 percent to $20.5 billion. Net revenues gained 4.3 percent to $28.5 billion from $27.5 billion.

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