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Sears Holdings (NASDAQ: SHLD ) has been widely discussed in the value investing world ever since billionaire investor Eddie Lampert took control of the company in 2005. Sears Holdings' stock price reached a high of $192 in 2007 but has since plummeted to $50 per share and may go lower.
At this point, Sears Holdings looks more like a value trap than a value investment. There is a good chance that it will file for bankruptcy protection in the next couple of years. There are three good reasons why investors should sell Sears Holdings and move on to another investment:
1. No end in sight for Sears Holdings' declining comps
There is no disagreement that Sears Holdings is struggling. The company closed more than 300 stores in the last three years and it is still facing declining same-store sales. In the third quarter of 2013, same-store sales declined 4% at Sears, 2.1% at Kmart, and 3.1% overall.
Part of Lampert's plan to revitalize the 120-year-old retailer is the ShopYourWay program -- basically an e-commerce website that gives members rewards and discounts on Sears and Kmart merchandise. ShopYourWay is supposed to enable physical stores to carry less inventory; a store might carry two colors of one shirt and the website might carry another six colors. That way, stores do not have to carry every variety of every product because customers can try on the clothes in-store and order online.
But ShopYourWay may end up being a disaster for the retailer. Already, 70% of sales volume comes from customers in the ShopYourWay program, but ShopYourWay discounts cost Sears Holdings $75 million in the third quarter alone. The deals and rewards that make ShopYourWay attractive are only pushing Sears Holdings closer to bankruptcy.
2. Sears Holdings has no competitive advantage over Macy's or Wal-Mart
Sears Holdings, Macy's (NYSE: M ) , and Wal-Mart Stores (NYSE: WMT ) compete with one another in various product lines. Sears has a slight advantage in home appliances -- its specialty -- but Macy's and Wal-Mart can offer at least as good of a deal as Sears in everything else. Aside from home appliances, there is little that differentiates Sears from Macy's and Wal-Mart in a meaningful way and therefore customers switch freely between the three based on price and convenience. In other words, except for a few branded product lines, Sears sells commodity products.
The only way to earn out-sized profits in a commodity business is to be the low-cost producer. In retail, low-cost production comes from massive scale that leads to operating efficiencies. Wal-Mart, the world's largest retailer, has scale that can't be matched. Even so, Morningstar calculates Wal-Mart's return on invested capital in the low teens -- not particularly impressive compared to companies in other industries with similar competitive positions.
If Wal-Mart's return on invested capital only barely hits double-digits, Macy's and Sears Holdings' ROIC must be much lower. Morningstar calculates Macy's return on invested capital in the mid-single digits. Meanwhile, Sears Holdings is not even generating a profit. Macy's is an average business in a highly competitive industry and Sears Holdings is a bad business in the same industry -- neither is in a position to gain significant market share.
3. Sears Holdings has a high debt load
According to its most recent quarterly report, Sears Holdings carries $4.7 billion in long-term debt and another $2.7 billion in pension liabilities. The company has only $600 million cash on hand. This means the company has $6.8 billion in net debt and pension liabilities.
Troublingly, Sears Holdings has negative earnings before interest, taxes, depreciation, and amortization and negative free cash flow. The only way to stay afloat is to sell off assets, but that would leave the company with even less cash coming in the door in future quarters unless it can turn itself around.
If Sears Holdings did not have the debt, it would have several more years to figure out how to turn itself around. However, the enormous debt burden puts a timer on the turnaround plans -- and nothing coming out of the quarterly filings suggests that a turnaround is imminent.
No turnaround necessary for this stock
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