Can Sears Create Value by Cutting the Cord With Canada?

Sears is rumored to have its Canadian operations on the auction block, a transaction that could net it more than $700 million. Would it create value for Sears' investors?

Jun 14, 2014 at 11:30AM

Iconic retailer Sears Holdings (NASDAQ:SHLD) continues to struggle to find its way back into the black despite shedding a number of underperforming, non-core businesses over the past few years, including its Orchard Supply Hardware and Sears Hometown & Outlet units in 2011 and 2012, respectively. The company's latest financial update brought another poor data point, as evidenced by a top-line decline and a sizable operating loss.

Of course, with a significant debt load and legacy pension obligations, the company needs to continue doing whatever it can to improve its financial profile and return to profitability, in order to better compete with strong, focused operators like Dillard's (NYSE:DDS) and Home Depot (NYSE:HD). Sears' latest gambit is a rumored sale of its stake in Sears Canada, which is worth more than $700 million at current prices. So would the move be good for investors?

What's the value?
Despite an operating history that dates back to the 1950s and a sizable customer footprint that includes 3 million catalog shoppers, Sears Canada hasn't done much for Sears lately; it reported lackluster results in fiscal 2013 that were highlighted by a top-line decline and break-even profitability. Worse, the unit's performance has downshifted further in fiscal 2014 with comparable-store sales down 7.6%, a data point that management blamed on inclement weather and heavy promotions during the period. Combined with selective store closures, the net result for Sears Canada was a double-digit sales drop and a larger operating loss versus the prior-year period.

While Sears Canada and its roughly $3.9 billion in annual sales undoubtedly provide economies of scale for Sears' global purchasing operation, Sears would anecdotally seem to be better off monetizing its Sears Canada stake and redeploying the funds into its domestic growth initiatives, including its growing Shop Your Way loyalty program. In addition, the cash windfall could help the company fund investments in greater inventory selection in key product areas, like apparel and hardware, as it tries to steal customers away from stronger competitors.

An uphill battle against these competitors
In the apparel category, those competitors include Dillard's, a regional department store chain that seems to benefit from the stewardship of its founding family. This influence likely helped the company resist the urge to get big, as instead it has chosen to stay closer to its roots. It currently operates a network of roughly 280 stores that are focused on markets in the Southeast and Midwest U.S. 

Dillard's has also spent time to cultivate a popular assortment of private-label brands that generate approximately 21% of its sales. This strategy has been partially responsible for a huge pickup in its operating profitability over the past five years, even though its store base shrank over that same period. The net result for Dillard's has been strong and growing cash flow, which funds both further product development and the return of capital to shareholders.

In the hardware category, the competition is even tougher, with Home Depot and Lowe's controlling a sizable percentage of the home improvement industry's sales, estimated at more than 40%. Home Depot, in particular, has been using its sizable operating cash flow -- $7.6 billion in its latest fiscal year -- to invest in a greater inventory assortment in key product areas; this includes the appliance category, where the company hopes to eventually unseat Sears as the country's largest appliance seller. Home Depot has also been attempting to improve its value proposition for customers, highlighted by more customer service reps in its stores and more online shopping capabilities, in a bid to give customers one fewer reason to shop at competitors like Sears.

The bottom line
Dumping its weakly performing Canadian operation should be a no-brainer for Sears, given that the unit seems to be currently valued on its potential, or perhaps hidden asset values, rather than its recent profitability. A sale would certainly go a long way toward shoring up Sears' balance sheet and would provide funds to further accelerate the development of its Shop Your Way loyalty program, Sears' current focus and likely its best hope for a return to operating profitability. In the process, this would create shareholder value and could turn Sears into a long-term winner for investors.

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Robert Hanley owns shares of Sears Holdings and Dillard's. The Motley Fool recommends Home Depot. The Motley Fool owns shares of Dillard's and Sears Hometown and Outlet Stores. 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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