It's been years since Sears Holdings (NASDAQ:SHLD) last reported a profit, yet the company's stock has been surprisingly resilient. Many investors have found Sears attractive due to its large portfolio of real estate.
However, the company's ongoing losses are so substantial that they can soak up cash just about as fast as Sears can sell off assets. Indeed, Sears reported another big loss last week, and there is no sign that profitability will rebound. As a result, shareholders are unlikely to extract much value from Sears in the end.
More big losses
In the third quarter, Sears posted a GAAP loss of $534 million, notably worse than last year's loss of $498 million. Year to date, the company has lost slightly more than $1 billion. Domestic comparable-store sales continued on their downward trajectory, dropping 3.1% year over year. Gross margin also suffered for a variety of reasons, falling from 25.4% in third-quarter 2012 to 23.3% last quarter.
Sears has been steadily taking "strategic actions" to boost value for several years. This has included closing unprofitable stores in order to stem losses and selling off its most desirable real estate to generate cash. Recently, the Sears Canada subsidiary announced a new series of transactions to sell some of its best store locations and other real estate assets. Sears is also considering spinoffs of the Lands' End brand and its chain of auto centers.
While each of these transactions may create value individually, Sears' previous value-creation attempts have not fully offset its weak core performance. At this point, there's no reason to believe that the newest round of strategic actions will be any more effective.
A questionable strategy
The real problem for Sears Holdings is that while it owns some well-respected brands like Lands' End, Kenmore, DieHard, and Craftsman, the two core retail brands (Sears and Kmart) have lost their luster. In this context, management's grand plan to turn Sears and Kmart into "membership-oriented" businesses seems suspect.
The idea is to use the Shop Your Way rewards program to form deeper relationships with regular customers. Rather than using traditional promotional markdowns to drive traffic, the company will establish a tiered rewards system to encourage customers to spend more money with Sears and Kmart. Building deeper relationships with customers would also provide more data to enable individually targeted promotions.
Sears management has repeatedly told investors that the move to a membership-oriented model will hurt gross margin in the short run, as the company is still using promotional markdowns and rewards points to attract customers. However, the company's goal is to eventually dial back the traditional promotions, leading to a higher gross margin in the long run.
One problem is that plenty of other retailers have rewards programs, but most of them still use markdowns to drive traffic. Given that sales are continuing to fall despite the combination of promotional markdowns and rewards points, I am skeptical that Sears Holdings will ever wean customers off promotions. (It didn't work too well for J.C. Penney, either.)
More broadly, Sears and Kmart are not the kind of brands that will have an easy time converting customers to "members." How many people will really want to associate themselves closely with Sears or Kmart? Costco and Amazon.com have loyal membership bases because they deliver great value without seeming "cheap." By contrast, "cheap" is exactly the word many U.S. consumers would use to describe Sears and Kmart today.
Sears executives talk about turning the business around through a new membership-oriented business model, but at best it's unclear whether this is a realistic goal. In the meantime, Sears continues to lose hundreds of millions of dollars every quarter, which will eat up the proceeds of its asset sales for the foreseeable future. In this context, investors would be advised to stay away from Sears Holdings.