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SHLD AT A GLANCE

P/E ► 3K VERY HIGH EV/EBITDA ► 11.4 AVG ROA ► 0.9% AVG ROE ► -0.1% AVG Debt to Equity ► 2.04 AVG Current Ratio ► 1.20 VERY LOW Interest Coverage Ratio ► 1.12 AVG

 

 

 

 

 

 

Sears Holdings (NASDAQ: SHLD) is the third largest general merchandise retail company in the United States after Wal-Mart (WMT) and Target (TGT).^[1] The company generated over $46 billion in sales in 2008 from 2,297 full-line and 1,233 specialty retail stores in the United States and 388 full-line and specialty retail stores in Canada.^[2][3] SHLD operates under the Sears and Kmart names in the US and Canada. Product offerings in SHLD stores include apparel, jewelry, appliances, hardware, sporting goods, car repair services, home improvement services and electronics.

The company was formed in 2005 by the merger of Sears Roebuck (Sears) and Kmart Holdings. The merger was coordinated by Edward Lampert, the current Chairman, whom now holds over 54% of the shares outstanding through his hedge fund ESL Investments.^[4] Despite strong brand recognition, Sears Holdings, as with Kmart and Sears before it, has suffered several successive years of falling sales and market share erosion. These negative trends can be largely attributed to increasing competition in the industry. Other retail giants such as Wal-Mart Stores (WMT) and Target (TGT) have been aggressively capturing ever greater amounts of customers' wallet share through expanded selections and steeper discounts. In addition, the company has also struggled through the economic recession as consumers cut back on discretionary spending. Domestic comparable store sales decreased 8% in 2008 and the company's net income fell from $1.5 billion in 2006 to just $53 million in 2008.^[2]

Company Overview

Sears Holdings is composed of three business segments: Kmart, Sears Domestic, and Sears Canada. As of the end of FY 2008, the firm had no international presence outside of Canada. SHLD's product assortments in both Sears Department Stores as well as Kmart SuperStores and Discount Stores cover virtually all product categories: clothing, major home appliances (refrigerators, dishwashers, etc.), home improvement/home repair, auto repair services, and groceries.

The Merger

In November 2004, Kmart Holdings bought Sears Roebuck for $11 billion. The merger created a new company called Sears Holdings and was the third largest retailer in the country at the time.^[4] Before the merger, both companies, although well established since the 1800s, were struggling to compete against big box retailers like Wal-Mart (WMT) and Target (TGT). The idea behind the merger was to leverage the strength of both companies -- the reputation and service of Sears and the low prices of Kmart -- in order to compete with the new retail giants.^[5] In addition, Sears primarily conducted its business in a mall-based format, whereas Kmart used large off-mall locations. By merging, the new Sears Holding could grow outside of the traditional mall setting without having to risk investments in new stores.^[6]

Business Segments

• Kmart (34% of total revenue): Kmart is a general merchandise and discount chain that competes directly with Wal-Mart (WMT), Target (TGT), and other mass merchant stores. In 2008, Kmart stores earned $16.2 billion in net sales, down 6% from 2007 sales of $17.3 billion as a result of a 6.1% decrease in comparable store sales. At the end of 2008, SHLD operated 1,368 Kmart stores of which 1,321 were discount stores that sell general merchandise, home appliances, footwear, and some even included a pharmacy. 47 stores were Super Centers that are open 24 hours a day and include full-service grocery in addition to general merchandise. The company closed 14 stores in 2008 and plans to close 16 Kmart stores in 2009. Kmart has the lowest profit margins out of SHLD's segments with a 23.3% gross margin and a 1.1% operating margin in 2008.^[7]

• Sears Domestic (54% of total revenue): The Sears Domestic segment is comprised of full line department stores that sell general merchandise ranging from clothes and electronics to tools and appliances, specialty stores (i.e. Sears Hardware), Direct-to-Consumer Land’s End operations, and Home Services stores. In 2008, Sears Domestic stores generated $25.3 billion in net sales, down 9% from the $27.8 billion in sales in 2007, due to a 9.5% decrease in comparable store sales. At the end of 2008, SHLD operated 2,162 Sears Domestic stores, of which 929 were full-line stores and 1,233 were specialty stores. The number of Sears domestic stores increased a net 77 stores from 2007. Sears Domestic stores operated a net loss of $237 million in 2008, down almost $1 billion from 2007. The operating loss was a result of lower gross margins and lower sales levels, primarily driven by fewer sales in home appliances, household goods, apparel, tools, and lawn and garden categories. ^[8]

• Sears Canada (11% of total revenue): Sears Canada is a consolidated, 73% owned subsidiary of Sears that conducts similar retail operations as Sears Domestic -- Sears Canada is composed of both full-line and specialty Sears-brand stores similar to Sears Domestic stores but with a greater sales emphasis on apparel and other softline products. In 2008, Sears Canada generated $5.2 billion in revenue, down 6.5% from 2007, as a result of unfavorable exchange rates. At the end of 2008, the company operated 388 Sears Canada stores, a net increase of 8 stores from 2007. The Sears Canada Segment was SHLD's most profitable segment in 2008, with a gross margin of 31.4% and operating income and operating margin of $367 million and 7% respectively.^[9]

Only 11% of SHLD's revenue come from international stores, all of which are located in Canada.^[9]

Brands

SHLD owns and trademarks many popular brands which help to increase company visibility and boost sales. Some of the company's most popular brands are:

• Craftsman
• Kenmore
• Diehard
• Lands' End
• Jaclyn Smith
• Joe Boxer
• Apostrophe
• Covington brands

SHLD has securitized the Kenmore, Craftsman, and Diehard brands into KCD IP (Kenmore Craftsman DieHard intellectual property), a wholly owned, bankruptcy-remote subsidiary. In addition, the company also has th rights to sell an exclusive line of Jaclyn Smith and Martha Stewart Everyday products.

Business Growth

FY 2008 (ended Jan 31, 2009)^[2]

• Net income decreased 93.6% from $826 million in FY2007 to $56 million in FY2008. A large factor in the substantial decrease cam from $437 million in charges related to goodwill and asset impairments, store closings, and severance. Excluding these charges as well as others, the company's net income was $215 million in FY2008, a 74% decrease from FY2008. The decline in net income was primarily due to declines in gross margins due to increased markdowns and an effort to reduce inventory levels as a result of the economic downturn.

• In FY2008, total sales was $46.8 billion, a decrease of 7.6% from $50.7 billion in FY2007. The decrease in revenue was primarily caused by declines in sales in Sears Domestic and Kmart stores, at $2.5 billion and $1.0 billion respectively, due to lowered demand for discretionary consumer goods during the recession -- as a result, overall domestic comparable store sales decreased 8.0%.

• Domestic comparable store sales decreased 8.0% in FY2008. Specifically, comparable store sales at Sears Domestic and Kmart stores decreased 9.5% and 6.1% respectively.

• Operating profit margin decreased 250 bps from FY2007, totaling $302 million, or 0.6% of net sales revenue.

• At the end of FY2008, SHLD operated 3926 stores, a net increase of 66 stores when compared to the 3860 stores open at the end of FY2007.

Q3 FY2009 (ended October 31, 2009)^[10]

• SHLD's Q3 net income was negative just as it was in the previous-year fiscal quarter. In 2008 the company had a net loss of $146 million and in 2009 the the company did slightly better with a net loss of $127 million. The company faced a number of additional expenses which included domestic pension plans, hedging transactions, costs attributed to store closings and severance, etc.

• Net sales were $10.7 billion in Q3 2009, down 4.4% from net sales of $10.2 billion in Q3 of last year. The decrease in net sales can be attributed to a decrease in domestic comparable store sales, foreign currency exchange rates, and the weak U.S. economic environment.

• Comparable store sales for US Sears stores decreased by 4.6% during Q3 2009, while Kmart comparable store sales saw an increase of 0.5%. In particular, the home appliance and household goods, and home and garden at Sears domestic stores were hit hard by the weak housing market. Overall, domestic comparable store sales were down 2.3%.

• Operating loss for Q3 2009 was $106 million, compared to an operating loss of $202 million Q3 2008. The weak operating margin reflects SHLD's expenses related to domestic pension plans and store closings.

• The company had a net increase of 20 stores during the 9 months ended on October 31, 2009.

Trends and Forces

Department Store Migration to Off-Mall Locations

Before the 2004 merger, Sears stores were primarily located in malls and Kmart stores were located in off-mall locations. However, at the end of 2008, over two thirds of Sears Holdings stores were located in off-malls locations. SHLD is actively expanding into the off-mall trend in order to increase sales and stay ahead of competitors. For example, Kohl's (KSS) is a leader in the off-mall trend, operating 938 of its 1004 stores in off-mall locations at the end of 2008.^[11] J.C. Penney (JCP) operated 1,093 stores at the end of FY08, only 91 of which were off-mall,^[12] but, JCP is trying to catch up to companies such as Kohl's, as 31 of their 35 new stores in 2008 were off-mall. In 2009, 16 out of the 17 new stores JCP plans to build will be off-mall.^[13] Even though Sears is ahead of most of its competitors with regards to this trend, the company still lags behind big-box retailer Wal-Mart (WMT), which operates most of its over 3000 stores in off-mall locations.

Since the 2000's began, consumers have shifted their shopping habits to strip-malls and shopping centers rather than traditional malls^[11]Department stores are traditionally attached to malls, but have begun moving out into shopping centers and other "off-mall" locations to follow the changing customer's shopping patterns. Off-mall stores are cheaper to operate than traditional mall-based department stores, due to smaller real estate costs and less in-store employees, and offer consumers convenience by serving as a one stop shop. Sears is positioned to gain from this trend as more than half of its stores are in off-mall locations.

Growing Sears' Exclusive and Private Brands

Department stores are increasingly seeking to distinguish themselves and earn higher profit margins by offering exclusive brands and private label brands. Exclusive brands are brands marketed under the wholesaler's name that are sold only in a particular chain; one exclusive brand at Sears is the Craftsman line that can only be purchased online or at Sears stores. Private label brands are produced by wholesalers, but sold under the brand name of the retailer. Exclusive brands such as Kenmore and Craftsman, can help draw customers into Sears stores, as the products can only be found at Sears. ^[14]

Competition

Sears Holdings is the third largest general merchandise retailer in the world (in terms of net sales) behind big box retailers Wal-Mart (WMT) and Target (TGT), whose enormous scale allows each to extract value in their inventory purchases and pass these savings on to consumers. SHLD's competitors in the mid-tier department store industry include Macy's Inc. (M), J.C. Penney (JCP), and Kohl's (KSS).

• Wal-Mart (WMT): is the world's third largest company^[1] with 7,873 stores worldwide. Because of its mammoth size and buying power, Wal-Mart can buy its products at rock-bottom prices, exchanging high purchase volumes for low cost while passing the savings onto its customers.^[15]

• Target (TGT): operates 1,682 stores in 48 states. Target offers a range of general merchandise in a similar store format to Wal-Mart but targets a higher income demographic than that of Wal-Mart.^[16]

• Macy's Inc. (M): is a mall-based department store chain and carries extensive offerings from Polo Ralph Lauren (RL), Calvin Klein, Kenneth Cole Productions (KCP) and other fashion brands. Macy's is far smaller than Sears in terms of sales ($24.9 billion in FY08) and number of stores (847 at end of FY08).^[17] The company targets a higher income demographic than Sears.

• J.C. Penney (JCP): is similar to Macy's but operates in off-mall locations as well. The company significantly smaller than Sears, with far greater 2008 sales and stores than Sears ($18.5 billion; 1,093).^[18] J.C. Penney's prices are comparable to Macy's but JCP carries less prominent brand name merchandise but still targets a higher income demographic than Sears.

• Kohl's (KSS): appeals to middle-class consumers with discounted branded and private label clothing and home goods, and its $16.4 billion of sales in 2008 place it well behind Sears. The company operates over 1,000 stores most of which are in off-mall locations.^[19]

References

1. ↑ ^{1.0 1.1} CNN Money "Fortune 500"
2. ↑ ^{2.0 2.1 2.2 2.3 2.4} SHLD 2008 10-K, pg. 19
3. ↑ SHLD 2008 10-K, pg. 11 and 12
4. ↑ ^{4.0 4.1} MSNBC "Kmart to acquire Sears in $11 billion deal" 17 Nov 2004
5. ↑ CNN Money "The Kmart-Sears deal" 17 Nov 2004
6. ↑ SHLD 2008 10-K, pg. 4
7. ↑ SHLD 2008 10-K, pg. 2 and 29
8. ↑ SHLD 2008 10-K, pg. 3, 32-33
9. ↑ ^{9.0 9.1} SHLD 2008 10-K, pg. 4 and 35
10. ↑ ^{10.0 10.1 10.2} SHLD Q3 2009 Report, pg. 1
11. ↑ ^{11.0 11.1} KSS 2008 10-K, pg. 13
12. ↑ JCP 2008 10-K, pg. 8
13. ↑ JCP 2008 10-K, pg. 30
14. ↑ Seeking Alpha "Unseen Value in Sears' Brands" 13 March 2008
15. ↑ WMT 2009 10-K, Exhibit 13, pg. 46-47
16. ↑ TGT 2008 10-K, pg. 7
17. ↑ ^{17.0 17.1} M 2008 10-K, pg. 15
18. ↑ ^{18.0 18.1} JCP 2008 10-K, pg. F-3
19. ↑ ^{19.0 19.1} KSS 2008 10-K, pg. 18
20. ↑ WMT 2009 10-K, Exhibit 13, pg. 1
21. ↑ TGT 2008 10-K, pg 26