The Sears Holdings Death Spiral Continued Over the Holidays

During the past week, numerous retailers have reported strong sales results for the November-December holiday shopping season. Even mall-based department stores saw a rebound in sales, including by a 3.4% comp sales increase at J.C. Penney (NYSE: JCP).

However, this retail recovery didn't extend to Sears Holdings (NASDAQ: SHLD), which posted another ugly sales decline during the critical holiday period. While the company has announced another round of cost-cutting and capital-raising activities, it's becoming increasing clear that Sears is headed for bankruptcy in a year or two.

Sales plummet again

Back in early November, Sears rolled out a strategy of putting the whole store on sale in advance of Black Friday in order to beat the holiday rush. The company also decided to rely on nostalgia to drive sales. It brought back the iconic Sears Wish Book catalog, as well as Kmart's famous blue light specials.

However, Sears and Kmart did not run a single TV ad after Thanksgiving weekend, according to a recent Wall Street Journal report (subscription required). (Meanwhile, J.C. Penney spent an estimated $27 million on TV ads during the first 29 days of December.)

Not surprisingly, the lack of TV exposure vastly outweighed any benefits from Sears Holdings' other strategy changes. During the first nine months of fiscal 2017, comp sales fell 12.2% year over year, and the pace of decline actually accelerated during the holiday season. Whereas other retailers benefited from an inflection in sales trends starting in late October, Sears Holdings' comp sales plunged 16%-17% in the combined November-December period.

This highlights how J.C. Penney is eating Sears' lunch, particularly in the appliance market. J.C. Penney posted stellar 30% comp sales growth in appliances during the holiday period.

Earnings improvement is fading, as expected

For the past few quarters, Sears Holdings' main goal has been to restore adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to positive territory in 2018. Just six weeks ago, it was touting substantial progress in that regard, as adjusted EBITDA improved by $100 million in the third quarter (while remaining deeply negative).

At the time, I cautioned that year-over-year comparisons would be a lot tougher in the fourth quarter. Furthermore, rapid sales declines threaten to quickly offset the benefit of Sears Holdings' recent cost cuts.

Sure enough, Sears Holdings now projects that adjusted EBITDA will be around negative $40 million this quarter (plus or minus $30 million). At the midpoint of the guidance range, that would represent a meager $21 million year-over-year improvement, even though Sears is now benefiting from its full $1.25 billion cost-cutting program.

As part of its recent sales update, Sears Holdings disclosed that it plans another $200 million of cost cuts for 2018. It also recently decided to shutter another 109 stores in the next few months (after having closed more than a quarter of its stores in fiscal 2017). However, Sears' recent experience shows that these efforts are unlikely to improve profitability significantly.

Freeing up more cash

Given that Sears Holdings seems likely to continue burning cash at a rapid pace in 2018, it will need to keep selling assets to stay afloat. The company is still on track to close a deal to release a lien on 138 properties with an appraised value of $985 million in return for an immediate $407 million contribution to its pension plan. If all goes well, this could free up $500 million or more by the time Sears Holdings sells all 138 properties.

Meanwhile, the company recently closed a $100 million term loan and may be able to expand that loan to as much as $300 million in the future. Sears Holdings is also working to extend some of its near-term debt maturities while reducing its cash interest expense, but there's still work to be done on that front.

It's a matter of time

Sears Holdings' financial team is making a valiant effort to keep the lights on, in spite of the core retail operation's dreadful performance. Still, the company can't fund $1 billion-$2 billion of annual free cash flow outflows indefinitely.

A year ago, Sears Holdings owned the real estate for 293 Sears stores, 67 Kmart stores, and 20 smaller "specialty" stores. However, after selling more than $1 billion of real estate in 2017, it probably owns fewer than 300 of its stores today. That includes the 138 stores with a total appraised value of just $985 million (a substantial chunk of which is already earmarked for the pension plan).

If the remaining stores are of similar quality, they could be worth just $1 billion. Sears also owns its headquarters campus in the Chicago suburbs, a handful of distribution facilities, the Kenmore and DieHard brands, and a relatively successful home services unit. But while it still owns a fair number of assets, most of them are already being used as collateral for the company's roughly $4 billion of debt.

It's possible that Sears Holdings can monetize enough of these assets to limp through fiscal 2018. On the other hand, it's clear that the business itself is in a death spiral. By 2019 -- or 2020 at the latest -- this American retail icon is likely to disappear for good.

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Adam Levine-Weinberg owns shares of J.C. Penney. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.