Sears and Toys R Us Top the Retail Bad-News Hit Parade

In this segment of the Motley Fool Money podcast, host Chris Hill is joined by Million Dollar Portfolio's Jason Moser, Hidden Gems Canada's David Kretzmann, and Motley Fool Pro and Options' Jeff Fischer to consider the latest chapters in a pair of what have seemed like inevitable collapse stories: Sears (SHLDQ) -- though it turned a profit (sort of) in its fourth quarter -- is guiding for a poor 2018. And Toys R Us, loaded down by debt from the leveraged buyout that took it private and under siege from e-commerce, is liquidating immediately. The Fools talk causes, effects, lessons learned, and where the retail sector goes from here.

A full transcript follows the video.

This video was recorded on March 16, 2018.

Chris Hill: Last week, we started with good news from the world of retail. This week, not so much. Sears reported a profit for the holiday quarter, but guidance for 2018 has the stock down more than 6% this week. And last week, when we said Toys R Us would be liquidating their U.S. operation soon, we actually didn't realize it would be coming this week. Nearly 900 locations and 33,000 jobs going away at Toys R Us. Jason, nostalgia is really taking it on the chin this week.

Jason Moser: I think we all knew in our hearts, really, that Toys R Us was going to be announcing that sooner rather than later. And that's a shame. We certainly don't like to see people losing jobs. In regard to Sears, however, listen, anyone who thinks this company has a shot at turning things around is delusional. I normally like to try to approach things with a glass half-full sort of perspective but, there's no way, every earnings release is like, "This is what we're doing this quarter to counter this effect or try to unlock value," or whatever it may be. It feels like they're just throwing good money after bad. You mentioned profitability, Chris, but really, it wasn't profitability, and I hate to see the headlines even imply this. When you look at the net income number of $182 million, let's also remember that was thanks to a non-cash tax benefit of $470 million. So, really, it was not profitability but a lack thereof, Chris. Top line is still shrinking. Anecdotally, I took my daughter to the mall last Sunday, just cruised through the local Sears just to see how things were going.

Hill: Because you wanted some quiet time? [laughs]

Moser: Not good, Chris. Not good.

Hill: David?

David Kretzmann: Sears is really in a category of its own as far as being a train wreck in retail. But looking at Toys R Us, it wasn't just this transition to e-commerce that did Toys R Us in. The company really set itself up for failure 15-20 years ago when they brought on a lot of debt, relying on debt to finance the business. When things are good, when business is good, having some debt can really help leverage your results, and things look nice and rosy. But, the company was taken private about 13 years ago, and they were never able to get over that hurdle and pay down debt. They were so worried about covering those interest payments that they couldn't innovate with the business and build the e-commerce line. I think any retailer now that's relying on debt either to expand the business or buy back shares, in the case of Bed Bath & Beyond, you really have to take a step back as an investor and think, is that the wisest thing to do? Because I think you're just putting yourself in such a risky position if you're relying on debt.

Jeff Fischer: Yeah, David, and that speaks to how quickly the industry is changing right under their feet. As you mentioned, Toys R Us was taken private in 2005 for $6.6 billion, and about $5 billion in debt. They're paying hundreds of millions in interest every year. Meanwhile, their thought back then was, the toy industry needs to be consolidated, so they bought FAO Schwarz and KB Toys. The worst move they could possibly make. 

Back then, in 2005, Amazon had 4% of the sales that it has right now. So, Amazon has grown, what is that, maybe 25-fold? Is that even the right math? I don't think so. Amazon has grown so much. They, meanwhile, were not even moving in the right direction toward e-commerce. Anyone who's getting into the retail industry now, trying to save a Sears or a Toys R Us, has to take into account how quickly consumer habits are changing. And Toys R Us wasn't doing that, either. And it wasn't just e-commerce, either. Target and Walmart were selling more Mattel and Hasbro toys than Toys R Us the past year. So, Target and Walmart moving into toys also took a lot of market share.

Hill: I'm glad you mentioned Target and Walmart, because now we have close to a thousand locations that are going to be up for grabs. That's not including what's probably going to come in terms of Sears. Who's going to be taking this real estate? Does it make sense for Target or Walmart, or, for that matter, Amazon, to kick the tires on at least some of these locations? Because I have to believe they can get a deal, Jason.

Moser: That is the question, right? I think you're going to see some combination of what you just mentioned there. I think the bigger players in retail who are still building out the e-commerce operations could look at some of these locations, and maybe that whittles down the time of getting things from point A to point B. But I can't help but believe there's going to be a surplus of commercial real estate out there that's really not quite put to good use for some time to come.