Best Buy and Sears Holdings: Should You Avoid These 2 Retail Stocks?

Best Buy and Sears Holdings are in trouble because their customers are fleeing fast.

Jun 2, 2014 at 10:00AM

In the current economic climate of sluggish GDP growth and restrained consumer spending, there's only so much cash to go around for retailers. That means the job for investors is to separate the winners from the losers in the retail space.

Two retailers that are struggling right now are Best Buy (NYSE:BBY) and Sears Holdings (NASDAQ:SHLD). Their financial performance is in decline, and their future outlooks are questionable at best. When it comes to Best Buy, it's losing ground from the 'showrooming' effect, in which consumers look at items at Best Buy only to purchase them more cheaply online. The situation facing Sears is even more severe. It's quickly looking more and more like a relic of the past, and it's losing billions of dollars.

Add it all up, and Best Buy and Sears are two retailers that still have steep hills to climb before they're worthy of investment.

Not all retailers are created equal
For years, it was rumored that Best Buy was losing shoppers to a phenomenon known as 'showrooming.' Shoppers would supposedly look at items at Best Buy to receive the benefit of looking at them in person and asking questions to store employees, and then leave and purchase the items on Amazon.com and elsewhere at lower prices.

Best Buy

Source: Best Buy website

Best Buy fought these claims all along, insisting that the showrooming effect didn't exist. Unfortunately, it seems that it's all too real. Best Buy's sales at locations open at least one year fell 0.8% last year after a 3.5% drop in comparable-store sales in the previous year.  Unfortunately, the company isn't off to a great start in the current fiscal year, as first-quarter same-store sales fell another 1.9%.

Investors might be lulled into thinking Best Buy is a great value opportunity since it earned $1.31 in earnings per share in the first quarter. This represents a fourfold increase year over year. But underneath the surface, the results are far less impressive.

Best Buy's EPS was boosted by a huge income tax benefit related to a reorganization in Europe. When you strip this out to focus on core earnings, Best Buy's EPS increased by just 3% despite significant cost cuts. But with sales falling, there's only so much that can be achieved by cutting costs.

Sears

source: Wikimedia Commons

Sears Holdings and the mirage of real estate assets
Meanwhile, Sears is quickly losing its connection with consumers. Its namesake Sears as well as its Kmart brand simply don't resonate with shoppers today. The company hoped to buy time by spinning off Lands' End, but that strategic initiative hasn't gained traction or resulted in the turnaround investors had hoped for.

Despite receiving $500 million in proceeds from the spinoff, Sears lost $402 million in the first quarter alone. This came on top of a massive $1.4 billion loss last year.

Those bullish on Sears often point to its real estate assets as reason for optimism. But it needs to be stated that the value of any asset, including real estate, is only what someone else is willing to pay. As Sears keeps piling up losses, the value of its real estate erodes. In fact, the reported value of Sears' total net property and equipment fell by 10% last year.

Don't be lured into buying Best Buy or Sears
Economic activity is finally accelerating now that the brutal winter weather that took a bite out of retail sales is in the rearview mirror. And, consumers are feeling better about themselves, evidenced by resilient consumer confidence. As a result, it's easy to build a strong case for retail stocks. But not all retailers are created equal.

The economy is still difficult for millions of consumers in the United States. You need to understand which retailers are still doing well in this climate...and which ones aren't. Best Buy might look appealing on the surface given its huge EPS growth in the first quarter. For its part, Sears may tempt you with its real estate assets. But in both cases, the truth is that neither company is doing very well. There's simply no need to gamble on either retailer's questionable turnaround prospects.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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