Sears Holdings (OTC:SHLDQ) has burned an average of nearly $2 billion annually for the past several years. While a combination of deep cost cuts and rapid downsizing may start to stem the tide of red ink over the next year or so, there's no sign that the iconic retailer can get anywhere close to breakeven in the foreseeable future.
That's bad news for investors who haven't already fled Sears Holdings. The company is running out of assets that can be sold, and it has a substantial amount of debt maturing over the next two years or so. As a result, it will be challenging for Sears to make it to the end of fiscal 2019 without filing for bankruptcy protection -- and virtually impossible for it to survive past 2020.
Sears' financial position is weak
As of early May, Sears Holdings had $5.2 billion of debt and capital lease obligations. It also had a $1.3 billion pension deficit, offset by $280 million of restricted cash that will eventually be contributed to the company's pension plan.
Meanwhile, free cash flow is still deeply negative. Sears Holdings has burned more than $1 billion annually for five years running. 2018 isn't shaping up to be any better.
Sears has funded these losses by selling off billions of dollars of assets, primarily real estate. Its biggest asset sale was the spinoff of Seritage Growth Properties (NYSE:SRG), which paid the company $2.7 billion for its interests in 266 properties. Since then, Sears has been a rent-paying tenant of Seritage -- which has exacerbated the former's negative free cash flow -- although Seritage has recently been recapturing lots of space from Sears and releasing it to higher-paying tenants.
To a lesser extent, Sears Holdings has also increased its borrowings to fund cash shortfalls. However, in recent years, it has only been able to borrow on a secured basis by using real estate, brands, inventory, and other assets as collateral. Even then, CEO and top shareholder Eddie Lampert has frequently needed to step in as a lender of last resort -- and Sears has had to pay very high interest rates, even for short-term debt.
Major debt maturities loom
Another result of Sears' deteriorating financial position is that lenders have insisted on relatively short maturities for new borrowings. With the exception of a little more than $300 million of long-term debt due in the late 2020s and thereafter, all of Sears Holdings' debt (i.e. nearly $5 billion) matures between now and the end of 2020. These upcoming maturities give the company a very short window to turn the business around.
The good news -- if there is any -- is that as of early May, $2.8 billion of Sears Holdings' debt was held by related parties, mainly Lampert's ESL Investments hedge fund. In recent years, Lampert and ESL have shown an inclination to be flexible about extending debt maturities to avoid a liquidity crisis at Sears Holdings.
Much of the company's other near-term debt maturities are backed by high-quality collateral such as inventory and real estate. It would probably be possible to refinance these borrowings, given that the risk to lenders would be manageable.
On the other hand, Sears Holdings has $411 million of outstanding "old" senior unsecured notes maturing in December 2019. This debt is almost certainly held by third parties, not Lampert or ESL. It's highly unlikely that Sears will be able to extend this maturity or refinance it, given that there is no collateral attached to protect creditors' investments.
Sears also has virtually no chance of returning to positive free cash flow next year, so it will be very difficult to repay this debt. Thus, this maturity could be the straw that breaks the camel's back, forcing Sears Holdings to declare bankruptcy -- assuming it doesn't go bankrupt before then.
The asset base is running low
A few months ago, I estimated that Sears Holdings' assets could be worth around $8 billion. However, nearly all of those assets are now pledged as collateral to guarantee its debt and pension obligations.
Thus, to the extent that Sears can continue to sell assets, it will have to apply the bulk of the proceeds to repay debt and fund its pension plan. It has very few remaining unencumbered assets that it can use to secure additional debt. This will make it very challenging for the company to fund its cash outflows over the next 12 to 18 months -- even if it only burns $1 billion, compared to roughly $2 billion of cash burn over the past year.
Perhaps Sears Holdings can come up with enough cash to fund another year of losses. But finding more than $400 million thereafter to repay its unsecured debt in December 2019 seems like a long shot, to say the least. Time is running out for this iconic retailer.