One of the most famous brands of the last 100 years, Sears got its start in 1886 as a mail order catalog company and enjoyed more than a century of success as a retailer. Despite Sears' impressive history, the company's success reached a crescendo during the 2008 financial crisis. Since then, the company has experienced progressively worse earnings power and numerous setbacks in brand loyalty and consumer spending. Below is a look at the critical elements driving the company's destructive trend.
Cash Flows
Prior to the financial crisis, Sears had an operational cash flow of $1.5 billion a year. In short, the company was creating a product and service that had organic profits that allowed managers to invest capital and expand. Today, and for the last 5 years, the company has been unable to create a positive cash flow from it’s operating activities. In the past year alone, the company's cash flow was $-2.2 billion. For many companies, operational cash flows might oscillate between profitable and unprofitable years, but the trend for Sears has been nothing of the sort. The cash simply isn’t there.
When investors assess the intrinsic value of Sears by interpreting the expected cash flows into the future and adjust for an appropriate discount rate to estimate today’s price, where does one begin? The cash isn’t there and the growth is negative.
Looking at the numbers more specifically, an eyebrow raising area of concern is the company’s overhead. Does management really need to consume 27% of the company’s top-line revenue? For context, this figure is 7% higher than other profitable retailers like Wal-Mart.
The reason the company’s overhead is such a disturbing figure is because it demonstrates a culture that hasn’t moved beyond past success. Since 2007, the company’s overhead has consistently grown from 23% to 28.4% of the top line sales. For a company that has experienced a 54% drop in sales over the same period, one would think a fatter headquarters is a poor place to look for growth.
When viewing the company’s ability to add value in the face of competitors like Amazon and Ebay, Sears has an uphill battle. Traditional brick and mortar business like Sears have sky-high capital expenditures, a customer that buys products via smart phones while standing in their stores, and a consumer that only cares about maximum quality for the price. In the past, the Sears brand signaled value to consumers. Today, the company is an environment for market research as consumers view and compare products to prices on the web. When looking at the brand through the eyes of a millennial or younger consumer, the company signals an old, overpriced, legacy retailer.
What do you think the long-term future of SEARS might look like?
— Preston Pysh (@PrestonPysh) September 15, 2016
Macro Factors
When assessing the overall market forces in the fall of 2016, many expect credit conditions to become tighter and begin its contraction phase. This assessment is based on the changing trend in high yield bond yields, inventory levels, ISM manufacturing data, and numerous other factors. Although the Federal Reserve continues to signal the need for tighter monetary policy, the execution has been fairly fictitious. If the Fed actual makes good on their promise, tighter lending standards and an environment of credit contraction could wreck havoc on companies like Sears and other struggling retailers.
Based on the information contained in this short examination, existing shareholders should strongly consider the sale of their equity. Although the company could quickly turn into an acquisition target, the factors preventing new owners from reorganizing the company’s fixed costs will be challenging. With a continued decline in operational cash flow and a management that’s continuing to grow the staff, things are looking more like a nightmare than a turnaround.
