The latest financial maneuvers by Sears Holdings (SHLDQ) are being spun as a way to give the failing retailer some breathing room to get its house in order, but in reality, they indicate just how dire its predicament is. Worse, they could put the retailer's retirees at even greater risk.
Kicking the can down the road
Sears announced it was taking out additional loans totaling $607 million, with the proceeds being to be used to make a payment towards its pension obligations and for general corporate purposes. It also negotiated an extension to an existing loan that will see its repayment stretched out to next year, and possibly as far as mid-2019.
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One analyst wrote, "Sears appears to be working very hard to prove that the company has the liquidity to pay their vendors," which seems to be an exceedingly charitable way of saying the retailer's not generating enough in sales on its own to pay them, so it has to take out loans to do so. That's not an encouraging development.
Last quarter, same-store sales plunged by mid-teen rates at Sears and Kmart, an acceleration of the decline it's experienced over the past few years. While it narrowed its losses somewhat during the period, they still exceeded half a billion dollars. The Christmas season is typically the biggest for retailers, and Sears is no exception, but that's all relative, and having to arrange to have sufficient liquidity on hand after the holidays indicates Sears thinks more suppliers will want to break ties with them, as has happened over the past two years.
While there's enough room for conjecture on whether taking out new loans to pay the bills is good for Sears or not, the financial gymnastics should have Sears retirees worried.
Data source: Sears Holdings quarterly SEC filings. Chart by author.
The ticking time bomb
In March 2016, Sears entered into a five-year agreement with the Pension Benefit Guaranty Corp (PBGC) to protect the retailer's pension plans. In exchange for the PBGC not initiating an involuntary termination of its plans, Sears agreed to have the agency "ring-fence" various assets, or place a lien on them, to protect their value.
One of those assets was Craftsman tools, and Sears had to get a waiver from the PBGC to allow it to sell the brand to Stanley Black & Decker (SWK -0.01%) for $900 million. To do so, Sears agreed to use a $250 million payment it will be getting from Stanley three years after the deal closes for its pension contribution that would be counted towards its obligations for 2017, 2018, and 2019, and it would also contribute to the pension the 15-year stream of revenue it negotiated from Stanley.
Sears pension plan is massively underfunded by some $1.5 billion as of the end of 2016. The retailer estimated that it would have to make a contribution to the plan of $312 million this year and $297 million next year.
While it's uncertain how much of this year's obligation Sears has paid so far, the deal it just made with the PBGC will require it to make a $407 million payment to the pension plan, after which it won't have to make another one for two more years (it will need to make a $37 million payment this month and a $20 million supplemental payment in the second quarter of 2018).
The risk in de-risking
Earlier this year, Sears sought to "de-risk" its pension plan by transferring $515 million in pension liabilities to MetLife (MET 1.49%) by purchasing an annuity contract. Some 51,000 retirees will receive their full pension benefits from the insurance company rather than from Sears. It did it again in August when it purchased a second annuity contract for $512 million worth of liabilities that will have MetLife paying future benefits for 20,000 retirees. Other companies such as J.C. Penney, Kimberly-Clark, General Motors, and Verizon have made similar de-risking moves.
While this relieves Sears of the obligations for the pension, improving its financial condition since pension contributions consume a large percentage of Sears available cash -- it has made $4.5 billion in pension contributions since merging Sears and Kmart -- it's not necessarily in the best interest of retirees since the Employee Retirement Income Security Act (ERISA) no longer governs the benefit, and the PBGC no longer ensures it. Instead, various state agencies now oversee it.
The future comes at you fast
There is a good argument to be made that retirees who were switched over to MetLife are better off than those remaining at Sears since the insurer is a far healthier institution than is the retailer. Yet Sears is still effectively kicking its remaining pension plan can down the road for several years, during which time it will be selling off or further leveraging properties that are the assets financing the pension plan.
Although it has, indeed, given itself some breathing room, all of those problems will come back with a vengeance when the time clock expires. Because its business is not improving but rather deteriorating more rapidly, assuming Sears is even around in two years, it will have to resort to further financial gymnastics to put out the new brush fires that will flare up.
The retailer is taking out ever more loans to juggle its payments, but the fuse on its pension obligations is still burning as Sears runs out of both customers and cash. What Lampert has chosen to do is leverage the company with debt to buy it time, but at some point, the weight will become too heavy. When it collapses, it will be the retirees who are standing in the rubble.
