Where Are the Ads for Sears and Kmart?

While watching commercials for Wal-Mart (WMT 1.32%), Best Buy (BBY -0.81%), HH Gregg (HGGGQ)and Macy's during breaks from The X Factor, I realized that not only would Tate Stevens probably win the contest even though Carly Rose Sonenclar is far more talented, but that I had not seen any advertising by Sears (NASDAQ: SHLD). It turns out there's a good reason: Sears' advertising budget has plunged  since hedge fund billionaire Eddie Lampert took control of the company, just like the stock price.

Sears Holding, the offspring of Lampert combining Kmart and Sears in March 2005, currently spends about $500 million in advertising.  By comparison, Wal-Mart, not exactly known for wasting money, has an advertising budget of $2.3 billion. That is almost a five-fold increase over the last decade for the world's largest retailer. The chart below shows that even though Sears has saved money by reducing its advertising, its stock price performance has been much poorer than Wal-Mart's. For Sears, the short-term savings are not resulting in long-term shareholder value.

WMT data by YCharts

Now, the whole purpose of advertising is to sell goods. If Sears were still moving inventory, then the savings in advertising would be justified. But as the chart below clearly shows, the cash conversion cycle for Sears is about six times worse than that for Wal-Mart. This critical measure loosely reveals how quickly a company converts cash in the bank into cash in the register. As the chart also reveals, the inventory sits much longer on Sears' shelves than it does on Wal-Mart's.

SHLD Cash Conversion Cycle data by YCharts

Bzzzt... wrong side of the float
At Sears, Lampert has managed to firmly insert the company on the wrong side of a crucial business equation. Every investment aims to maximize the principle of time value of money: The longer the investment takes, the more money you make from playing "the float." That is why Warren Buffett loves insurance companies. From the Berkshire Hathaway 2010 shareholder letter:

Insurers receive premiums upfront and pay claims later. ... This collect-now, pay-later model leaves us holding large sums -- money we call "float" -- that will eventually go to others. Meanwhile, we get to invest this float for Berkshire's benefit. ... 

Sears Holding is now paying for the float, rather than collecting from it. The simple principle of time value of money dictates that the longer Sears' or Kmart's inventory sits on the shelves, the more money they lose from those unsold goods. The chart below shows how sales for Sears have fallen more than three times faster than the industry average over the last five years, even as sales have risen for Wal-Mart, Best Buy, HH Gregg, and Macy's. Not only is sales growth for Sears weaker, but its pricing power, as measured by the gross margin, is also not nearly as strong as its competitor's.

SOURCE: The Motley Fool CAPS and FINVIZ

What a Fool should watch (other than The X Factor)
Lampert is a finance guy from Goldman Sachs who is looking to squeeze every penny that he can from Sears . Slashing the advertising budget is certainly one way to do that. But the direct result is more inventory going unsold as fewer shoppers are being drawn into the stores. When that happens, sales growth plunges as goods remain unsold.

Foolish investors should monitor the cash conversion cycle and days inventory outstanding to see if Sears and K-Mart are selling goods. Until those metrics improve for Sears Holding, the stock performance will not.