Earlier this week, Sears Holdings (NASDAQ:SHLD) gave investors some good news and some bad news.
The good news was that Sears expects to post its first quarterly profit in years when it reports earnings later this month. The bad news was that sales are still plummeting -- and the only reason for the quarterly profit was a big one-time gain from the recent spinoff of Seritage Growth Properties (NYSE:SRG), a REIT that bought interests in nearly 300 Sears properties.
Sears' management has done a decent job of extracting some value from the company through various spinoffs and asset sales in recent years. But Eddie Lampert and his team continue to extol turnaround plans that will transform Sears into "a leading integrated retail membership-focused company." Nevertheless, it seems highly doubtful that Sears will be able to avoid declaring bankruptcy in the next few years.
Sears reports preliminary results
On Monday, Sears announced that it expects to report net income of $155 million to $205 million for the recently ended second quarter. However, this figure includes some big one-time gains related the $2.7 billion sale of real estate properties to Seritage.
The gains include $510 million in gains on the sale that are recognized immediately. (Another $900 million in gains were deferred and will be recognized over time.) Sears also expects a tax benefit of $240 million related to the sale.
Looking at adjusted earnings before interest, taxes, depreciation, and amortization, Sears' financial position looks a whole lot worse. Sears estimates that figure -- which excludes some major cost categories -- at a loss of $189 million to $249 million, excluding $26 million in new rent expense caused by Sears' recent real estate transactions.
That's better than the $298 million of negative EBITDA that Sears reported for Q2 last year. However, Sears' underlying business is still falling apart. Comparable-store sales plummeted 10.6% year over year in the quarter. With sales declines of that magnitude, there's no way for Sears to cut its way to profitability.
Liquidity won't last
Sears boasted that its real estate sale to Seritage -- along with a few real estate joint ventures announced earlier -- has boosted its liquidity to $3 billion, up from less than $1 billion a year ago and about $1 billion at the end of Q1. Sears plans to use its cash proceeds from the Seritage deal to buy back $1 billion of outstanding debt.
However, the remaining $2 billion in liquidity won't last long. Operating cash flow was negative-$1.4 billion in 2014, and negative-$535 million just in the first quarter of this year. Based on Sears' terrible comparable-store sales trend, it will continue to burn cash at a high rate for the foreseeable future.
Furthermore, while the Seritage real estate sale gave Sears a big one-time liquidity boost, it will increase its cash flow problems going forward. Sears now must pay rent on those properties, with a base rate of $140 million per year. That more than offsets the $66 million of annual interest expense savings that Sears expects from paying down debt with the proceeds.
This can't last forever
Over the past few years, as Sears has hemorrhaged billions of dollars, the company has managed to stay afloat through a never-ending series of asset sales and spinoffs to raise cash. Sears still owns some real estate that it could sell, but eventually, that well will run dry.
Ultimately, sale-leaseback arrangements can't save Sears. If a store is losing money, splitting the real estate from the retail operation alone can't improve the total profitability of the two. It can only redistribute the losses.
The real point of the Seritage spinoff and asset sale is to put Sears' quality real estate to better use. Or, in other words, to use it as something other than a Sears or Kmart store.
The Sears and Kmart brands are so tarnished today that there's no realistic hope of recovery for either one. Sears executives are kidding themselves if they think otherwise. It makes more sense to wind the company down in a quick but orderly fashion to preserve the little value that's left. Otherwise, the most likely outcome is a forced bankruptcy a year or two down the road that leaves both employees and shareholders with nothing.