On Thursday, Sears Holdings (NASDAQ:SHLD) released another dreadful quarterly earnings report. Revenue plunged 27.2% to $3.66 billion, driven by a massive number of store closures and a 15.3% comp sales decline.
Sears Holdings stock still rose, as management said it had completed a $1.25 billion cost-cutting initiative ahead of schedule, leading to some modest earnings improvement. However, without a turnaround in its sales performance, Sears has virtually no chance of surviving more than another year or two.
Sears finally reports some earnings improvement
In the first quarter of fiscal 2017, Sears Holdings reported further deterioration in its profitability, due to a double-digit comp sales decline and margin erosion. In response, the company raised its cost-cutting targets. As a result, adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) improved by $124 million in Q2, although that still left it in negative territory.
Last quarter, adjusted EBITDA improved again relative to the prior-year period, this time by $100 million. (Adjusted EBITDA was still deeply negative at -$275 million.) Sears Holdings' net loss also decreased by nearly $200 million, although that was driven by higher asset sale gains last quarter.
Sears Holdings' management held up this second consecutive quarter of adjusted EBITDA improvement as a sign that the cost-cutting campaign is working. In fact, CEO Eddie Lampert vowed that adjusted EBITDA would turn positive in 2018.
Breakeven is nowhere in sight
Taking a deeper look at Sears Holdings' results, Lampert's bold prediction looks like hot air. After all, Sears already captured most of the benefits of its cost-cutting plan in its third-quarter results, yet adjusted EBITDA was still deeply negative.
Furthermore, Sears may be unable to maintain its recent pace of earnings improvement. In the fourth quarter of 2016, adjusted EBITDA improved by $76 million year over year, compared to a $48 million decline in the first nine months of last year. As a result, the company faces a tougher year-over-year comparison this quarter.
Assuming Sears posts a smaller improvement in adjusted EBITDA for the fourth quarter, its full-year adjusted EBITDA loss will come to approximately $600 million. That's a long way from positive territory. In fact, for adjusted EBITDA to turn positive in 2018, the pace of improvement would have to accelerate relative to Q3, even though Sears was already benefiting from most of its 2017 cost cuts then.
If sales continue to erode rapidly, it won't take long for the recent trend of earnings improvement to peter out -- unless management finds another $1 billion of cost cuts. The bottom line is that without meaningful sales improvement, cost-cutting can only provide a modest, short-term boost to earnings.
A liquidity crunch is on the horizon
The most damning part of Sears Holdings' Q3 earnings report was the cash flow statement. In the first nine months of fiscal 2017, operating cash flow fell approximately $500 million deeper into negative territory, reaching -$1.9 billion. Sears has only kept the lights on by selling roughly $1.5 billion of assets, mainly consisting of real estate and the storied Craftsman brand.
There's no reason to believe Sears Holdings will have it any easier in 2018. Furthermore, despite some recent attempts to reduce its near-term debt maturities, Sears still has about $400 million due on a term loan maturing in June 2018, and another $303 million of debt maturing in October.
To help meet its obligations, Sears Holdings recently negotiated an agreement with the Pension Benefit Guaranty Corporation that will allow it to sell 138 more properties (roughly half of its remaining owned stores). But in return, the company must contribute a total of $464 million to its pension plans between now and the middle of next year.
The net result is that Sears has bought itself some breathing room. However, after deducting the pension contributions and the payments on the company's expiring term loan, the proceeds from selling this real estate won't even get Sears through the end of next year.
In short, Sears Holdings is at risk of running out of cash next fall, just as its $303 million debt payment is due -- and just when it needs extra liquidity so it can stock up for the holidays. Barring a miraculous sales turnaround that would drive a sustainable uptick in earnings, the clock may be running out for this troubled retail giant.
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