Sears Holdings (NASDAQOTH:SHLDQ) is likely to release its second-quarter earnings results later this week. The struggling retail giant took a turn for the worse in the first quarter, as sales plummeted more than 30% year over year due to a combination of store closures and an 11.9% comp sales decline. As a result, Sears posted a big loss and burned more than $1 billion of cash during the quarter.
Sears is creeping ever closer to insolvency, due to its ongoing cash burn and the steady depletion of its once-massive pool of saleable assets. In this context, the company's Q2 results will give investors a better sense of whether the retail icon is truly doomed.
The analysts have given up
Over the past few years, as Sears Holdings' financial results have spiraled downward, Wall Street analysts have stopped following the company. The lack of analyst coverage means that investors' expectations aren't reflected in a public "analyst consensus" for sales and earnings.
However, for the second quarter to be considered remotely successful, Sears must have slowed its rate of sales erosion. Over the past four quarters, comp sales declines have ranged between 11.5% (in last year's second quarter) and 15.6% (in last year's fourth quarter). A single-digit comp sales decline would represent some level of progress -- although it would still hardly be a satisfactory result.
CEO Eddie Lampert has also set a goal of achieving breakeven adjusted EBITDA this year. This target seems very unrealistic, given that adjusted EBITDA was -$562 million in fiscal year 2017 and adjusted EBITDA declined slightly in the first quarter of this year. But a $50 million improvement (or more) in quarterly adjusted EBITDA would at least keep hope alive that Sears could eventually reach positive EBITDA. (That said, even if EBITDA eventually turns positive, Sears Holdings' crushing debt load may still make the stock worthless.)
There are some reasons to hope that sales and earnings trends may have improved last quarter. Warmer weather likely boosted sales of seasonal items like summer apparel, gardening supplies, grills, and A/C units. Additionally, retail sales growth accelerated over the past few months.
On the other hand, J.C. Penney (NYSE:JCP) posted weak Q2 sales and earnings results earlier this month and slashed its full-year guidance. J.C. Penney is arguably Sears' closest competitor. Its inability to participate in the retail rebound shows that strong market conditions didn't necessarily benefit weaker retailers. Sears suffers from many of the same weaknesses as J.C. Penney.
Keep a close eye on cash flow and the balance sheet
Sears Holdings ended the first quarter with just $457 million of liquidity, including $186 million of cash and equivalents. However, in mid-May, the company signed an extension of its credit card deal, reaping a $400 million windfall from Citigroup.
The second quarter tends to be a seasonally stronger period for cash flow at Sears Holdings. As a result, there's a good chance that free cash flow was positive last quarter, including the impact of the $400 million payment. Sears also continued selling real estate during the second quarter, which likely provided an additional liquidity boost.
Last year, Sears Holdings' liquidity plunged by $472 million in the seasonally weak third quarter, despite more than $270 million of asset sales. That makes it vital to have a big liquidity cushion entering Q3. Given that Sears has a $133 million debt maturity in October, it would be very troubling if liquidity were less than $800 million at the end of the second quarter.
Other recent highlights
As part of its effort to trim its losses, Sears Holdings is continuing to close stores at a rapid pace. Prior to the company's first-quarter earnings release, Sears had announced plans to close more than 40 stores over the summer. In conjunction with the earnings report, the company said it planned to keep downsizing. Since then, it has announced 124 additional store closures.
During fiscal year 2017, nearly three-quarters of the stores closed by Sears Holdings were Kmarts. A majority of the stores closed in the first quarter were Kmarts, as well. By contrast, about three-quarters of the store closures announced since April have been Sears locations.
This confirms that both chains are far from being healthy. Additionally, Sears Holdings' large numbers of store closures may be undermining sales at its remaining locations, as customers gravitate toward clearance sales at nearby stores being closed.
Finally, Sears Holdings may be close to announcing a deal to sell its Kenmore appliance brand and its SHIP home improvement business to CEO Eddie Lampert's ESL Investments hedge fund. Two weeks ago, ESL said it planned to offer $400 million for Kenmore and $70 million (plus a contingent payment of up to $10 million) for SHIP.
Selling those assets would provide much-needed liquidity to ensure that Sears Holdings can make it through the holiday season. However, it will come at a cost in terms of future earnings -- and it will leave Sears with even fewer assets that it can sell to raise cash in 2019.