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Don't Get Too Excited About Sears Holdings' Guidance Increase

By Adam Levine-Weinberg - Feb 20, 2018 at 8:25AM

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Sears Holdings' fourth-quarter profitability came in better than expected, but the company is still probably headed for bankruptcy.

On Thursday, beleaguered retail icon Sears Holdings (SHLDQ) released preliminary results for the fourth quarter that exceeded the company's most recent forecast.

Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) improved significantly on a year-over-year basis. This drove a 21% jump in Sears Holdings' share price last week -- although the stock has still lost more than a quarter of its value since the beginning of 2018.

SHLD Price Chart

Sears Holdings weekly stock performance. Data by YCharts.

However, investors should realize that Sears Holdings remains deeply unprofitable. Meanwhile, it is running out of assets that it can sell to cover its losses. There's no reason to believe that the company's recent guidance update heralds a true turnaround for Sears.

Sears raises its forecast

Last month, Sears Holdings reported dreadful results for the holiday season. Comp sales plunged about 16%-17% during the combined November-December period. As a result, Sears projected that adjusted EBITDA would remain in negative territory in the fourth quarter, ranging between a loss of $70 million and a loss of $10 million.

At the midpoint of that guidance range, adjusted EBITDA would have improved by $21 million year over year, far less than the $100 million improvement achieved in Q3. Considering how rapidly Sears Holdings is burning cash, it clearly needs to improve its financial performance at a much faster pace.

Sears had better news to report last week. The company now estimates that adjusted EBITDA was roughly flat (plus or minus $10 million) in the fourth quarter. It also reported that comp sales fell 15.6% for the full quarter. This implies that sales trends improved somewhat in January. Total revenue for the period fell to $4.4 billion from $6.1 billion a year earlier.

The exterior of a Sears full-line department store during the day with two customers about to walk in and cars driving in front of it

Sears' revenue continued to erode rapidly last quarter. Image source: Sears Holdings.

That said, breaking even in the most profitable quarter of the year after excluding major costs like interest and pension expense is hardly something to celebrate. Additionally, Sears Holdings' ongoing attempt to exchange some of its existing debt for new debt that would allow "payment-in-kind" -- i.e., paying interest with additional debt rather than cash -- highlights the company's worsening financial condition.

Just another January bounce

Investors should also note that this isn't the first time that Sears' sales trajectory has improved in January. For example, two years ago, management pointed out that comp sales dipped just 4.5% in January 2016, marking the best monthly performance of the company's 2015 fiscal year. The trend didn't last. Sears Holdings posted a full-year comp sales decline of 7.4% during fiscal 2016.

Sears saw a similar trend improvement in January 2017. Comp sales dropped 12%-13% for the combined November-December period of 2016, but fell by just 10.3% for Q4 as a whole.

January is one of the lowest-volume sales months of the year, as consumers work to pay off their holiday purchases. The seasonality of Sears' sales trends has changed in recent years, leading to better comp sales results during January than in the rest of the year. Yet Sears Holdings is still likely to experience another severe revenue decrease in 2018, offsetting its cost-cutting actions.

Racing against the clock

For the past three years, Sears Holdings has been burning about $2 billion of cash annually. That does include restructuring costs, but its downsizing efforts mean that the company is likely to continue paying a substantial amount in severance and lease termination fees for the next few years. Pension contributions will diminish following a $407 million payment in early 2018, but that will only make a small dent in the company's cash burn rate.

Following a massive cost-cutting effort in 2017, Sears Holdings' profitability is improving by hundreds of millions of dollars on an annualized basis. However, to reach breakeven free cash flow, it needs more than $1 billion of annualized improvement, excluding pension payments.

There's no sign that Sears is capable of this level of profit improvement. With the company's asset base quickly shrinking and creditors closing in, Sears Holdings will probably be forced into bankruptcy by the end of 2019, so investors should stay away.

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