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Is Sears Making A Mistake In Spinning Off Lands' End?

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On Friday, Sears Holdings Corporation (NASDAQ: SHLD  ) announced that it had decided to divest itself of another subsidiary; Lands' End. This marks the third such spinoff of an enterprise owned by Sears since 2012. With all of this wheeling and dealing, is it possible that the company is trying to better itself or is it trying to salvage some value by unloading the junk from a sinking ship?

Lands' End
Lands' End, which was founded in 1963, started off as a sailboat and hardware catalog set up by Gary Comer. In 1977 the company transformed into a clothing company and, in 2012, was acquired by Sears. Today, the business operates 14 retail stores, on top of 280 store-within-a-store models within Sears locations.

Although financial data on the company is scarce, we do know that it has been a primary cause of lower margins at Sears. Since at least the company's 2011 fiscal year, Lands' End's results are cited as one of the primary causes of lower gross margin achieved by the company.

This point is reinforced by the significant decrease in Sears locations that its store-within-a-store setup has been implemented. While 2010 saw an increase from 222 Lands' End setups to 293, this number has declined every year and currently sits at 280. 

There is some good news though.  According to one source, revenue for Lands' End has declined lately.  Between 2011 and 2012, sales fell 8.1% from $1.73 billion to $1.59 billion. Unlike the rest of Sears though, the company has generated some profit.  In the third quarter of 2012, net income came in at $8.8 million.  This is expected to increase during the third quarter this year to $12.7 million.  For the year, merchandise sales are expected to rise between 1.1% and 3.8% to as high as $385 million for the soon-to-be stand-alone entity. 

Sears has had disappointing results with its other spinoffs
In addition to this spinoff, Sears has spun off two other businesses recently. In 2012, the company announced the spinoff of its Sears Hometown and Outlet Stores (NASDAQ: SHOS  ) , a retailer of home appliances, hardware, etc... Looking back to the company's 2011 pro forma financial statements, we can see that revenue has increased by 4.5% from $2.35 billion to $2.45 billion.

During the same time period, the company's bottom line improved even more. From 2011 through fiscal 2013, net income rose by 20.7% from $49.8 million to $60.1 million. The discrepancy between revenue and net income growth can be explained by costs declining as a percentage of sales.

Despite the initial results of the company, its 2014 fiscal year has proven especially tough. Even though revenue rose by 1.9% from its second quarter of last year to the same quarter this year, the company's net profit margin has declined from 3.3% to 1.4%. The primary cause of this lackluster performance can be attributed to a 5% increase in the company's cost of goods sold.

Another poor performer spun off from Sears has been Orchard Supply Hardware. In January of 2012, the company began trading on the NASDAQ, but after facing financial difficulties, it filed for Chapter 11 bankruptcy in June of that year. In July, Lowe's Companies announced that they would buy the chain for $205 million in cash, close some of its locations and continue to operate the business as a separate entity from its core outlets.

Sears isn't alone in its woes
Sears isn't the only retailer struggling these days.  In fact, a significant number of retailers have been hit hard in recent years; perhaps none harder than J.C. Penney Company (NYSE: JCP  ) .  From 2011 through 2012, J.C. Penney saw its revenue decline by 24.8% from $17.26 billion to roughly $13 billion.  Net income has also been a major issue for the $2.5 billion company.  Every year since at least 2009 the company's bottom line has deteriorated, falling from net income of $572 million to a net loss of $985 million.  

Unlike Sears though, the company's situation does appear to be getting gradually better.  While the company's losses have widened this year, but management announced that it achieved comparable store sales of 0.9% in October, followed by an attractive 10.1% improvement in November.  Instead of spinning off its assets like Sears has done, J.C. Penney has started to improve as a result of increased sales and promotional events, ideas that Sears may want to imitate if it wants to survive.   

Foolish takeaway
Based on the data above, we can see that Sears appears to be ridding itself not of its quality assets, but of its low-quality ones. Though there is always the possibility that this could backfire on the company, it looks as though management is attempting to improve its core business instead of bailing the good assets from a sinking ship.

There is always the possibility that Lands' End will prove a success as a stand-alone operation, but empirical data doesn't seem to point toward that direction. Rather, it is more likely than not that Sears will see some moderate improvement in margins and a decrease in sales, while shareholders who decide not to sell their Lands' End stock might be left holding the bag.


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