After Another Bad Year in 2013, Should You Bet on a Rebound at Sears?

Mr. Market certainly doesn't think so, pushing Sears Holdings  (NASDAQ: SHLD  ) shares down double digits on Jan. 10 after the company's latest business update. The crux of the report was a continuation of comparable-store sales declines at both its namesake and Kmart units, with weakness across a large swath of categories. Despite the results, though, Sears has some formidable assets, including valuable real estate and brands like Craftsman tools and Kenmore appliances. So, is there a value story for investors to latch on to?

What's the value?
Sears has been slow to transform its business, despite the belief by some investors that it might become the next great holding company after its 2004 merger with Kmart, controlled by hedge fund manager Edward Lampert. However, the company has recently been moving faster to focus its businesses, separating off its Orchard Supply Hardware and Hometown & Outlet units in 2011 and 2012, respectively. 

Sears has also been trying to grow its online presence, reshaping its Shop Your Way loyalty program into an online marketplace, offering roughly 60 million products from both the company and third-party merchants.

Unfortunately, Sears' results have remained lackluster in fiscal year 2013, with a 7.2% top-line decrease that was caused by lower per-store sales production and selective reductions of its store network. Despite a stronger overall domestic housing market in 2013, Sears' significant exposure to the tools and appliances categories proved to be of little benefit, as they were among its worst-performing product areas. More important, Sears' operating cash flow remained weak, forcing it to rely on debt financings and asset sales to fund its capital expenditures.

On the upside, Sears has likely benefited from the near implosion of major competitor J.C. Penney (NYSE: JCP  ) , a fellow old-time retailer that similarly suffers from large pension obligations and a relatively heavy debt load. Unlike Sears, J.C. Penney spent the past couple of years investing heavily in its physical stores, part of a new everyday-low-price marketing plan that was poorly received by customers, leading to sharp sales declines. Fortunately, the company purged itself of the architects of the ill-fated makeover prior to going over the cliff, although the additional debt required to get itself back on track has severely weakened its financial position.

The murky path forward
After the recent divestiture activities, including prospective moves to spin off its Lands' End apparel and auto-center units, Sears has further increased its exposure to the hardware sector, an area that accounted for roughly 15% of total sales in its latest fiscal year. While that operating position plays to Sears' strength, given its status as the nation's largest appliance retailer, it also puts the company in the headlights of the mega home-improvement specialists, including leader Home Depot (NYSE: HD  ) .

In FY 2013, Home Depot has been operating in top form, reporting an 8.2% top-line gain, aided equally by a stronger pricing environment and higher customer volumes. Despite Home Depot's early exit from the Chinese consumer market, where it closed the last of its stores in 2012, the company has found growth in Canada and Mexico, which have risen to become roughly 12% of its overall sales base.

Home Depot has also been expanding its product mix, especially in the appliance area, with a focus on environmentally friendly Energy Star-certified products from leading manufacturers like Electrolux and Whirlpool. The net result of the company's business-enhancement efforts has better profitability and very strong operating cash flow, allowing Home Depot to further invest in its growth initiatives, including broadening its reach with its professional customer segment.

The bottom line
Despite getting roundly criticized for not investing in its stores, Sears likely saw a poor payoff, something that competitor J.C. Penney found out the hard way. Instead, the company has been selling off non-core assets in an attempt to improve its balance sheet and fund its online growth initiatives. 

Unfortunately, Sears is still a work in progress, given its inability to-date in attracting increasing numbers of customers to its stores and product offerings, not to mention the overhang of large debt and pension obligations. As such, while there surely is value within Sears' retail empire, risk-averse investors should likely take a pass.

Finding value in retail
To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.


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