SHLDQ - Sears Holdings Corp

[peridotcapital]

I think it is possible, but unlikely. In the presentation he notes that SYW points will soon be replacing traditional markdowns as a way to boost gross margins (right now shoppers are getting both). What he seems to be ignoring is the fact that such a move is just a fancy way of raising prices. Given the competitive retail environment right now (which he constantly cites), coupled with the demographics of the core Sears/Kmart shopper, I don't get why he thinks he'll be able to raise prices and not see a corresponding sales decline. Evidently he thinks offering in-vehicle pick-up and things like that will offset the impact. I doubt it.

 

I don't think that he plans to raise prices. It's just about the way markdowns are being done technically. If this turnaround works, it will work because he gets costs down ("asset light business model") by closing unnecessary or sizing them down. ESL is fully aware of the fact that the way to compete with AMZN is not renovating your stores and charging higher prices to pay for that.

 

He came out and said it directly, why should we not believe him? Gross margin can't go up if you don't get people to pay more for the same product (I am assuming wholesale costs are unchanged).

 

 

[peridotcapital]

Well, I found a bright spot on the retail side. I've been tracking selling/administrative costs as a % of revenue because this integrated retail business model is supposed to drive cost efficiencies and Eddie is laser-focused on costs anyway. Amazingly, S&A had actually risen 6 years in a row since the Sears/Kmart merger at Sears Domestic and 5 out of 6 years at Kmart. I found this to be telling. Kmart's S&A went up again in 2013, but Sears Domestic's finally went down. See the attached chart.

[Matson125]

In the webcast "as of today both Sears and Kmart have positive comp same store sales for February"

 

Hopefully they can keep it up.

[ni-co]

He came out and said it directly, why should we not believe him? Gross margin can't go up if you don't get people to pay more for the same product (I am assuming wholesale costs are unchanged).

 

Yes. You're right, but he also says on slide 22 of the presentation: "As model evolves, expect points to be substitute for PMDs, resulting in improved margin rate". He wants to replace PMD by points. What I don't understand is how this substitution is going to improve gross margin. Maybe, the membership discounts are more effective?

[ni-co]

"Also, as previously noted, we have continued with our traditional promotional programs at historical levels as we are intending to move through the transformation in a thoughtful and deliberate manner."

 

As far as I understand Rob Schriesheim, he's saying that they give more discounts than they normally would (points on top of the traditional promotional program) as they want people to get used to the points system. We'll see whether they will be able to scale traditional discounts back successfully. At the very least, they learned that lesson from JCP.

[peridotcapital]

He came out and said it directly, why should we not believe him? Gross margin can't go up if you don't get people to pay more for the same product (I am assuming wholesale costs are unchanged).

 

Yes. You're right, but he also says on slide 22 of the presentation: "As model evolves, expect points to be substitute for PMDs, resulting in improved margin rate". He wants to replace PMD by points. What I don't understand is how this substitution is going to improve gross margin. Maybe, the membership discounts are more effective?

 

That's exactly the quote I was referencing in my original post. He is saying gross margins are depressed now because they are using traditional markdowns to drive sales, and then giving points on top of that. Essentially two promotions. Over time he will cut back on the markdowns, hoping that points awards/redemptions will drive sales. The customer ends up paying a bit more (because they value the relationship experience) and gross margin goes up.

[BTShine]

He came out and said it directly, why should we not believe him? Gross margin can't go up if you don't get people to pay more for the same product (I am assuming wholesale costs are unchanged).

 

Yes. You're right, but he also says on slide 22 of the presentation: "As model evolves, expect points to be substitute for PMDs, resulting in improved margin rate". He wants to replace PMD by points. What I don't understand is how this substitution is going to improve gross margin. Maybe, the membership discounts are more effective?

 

Here's my thoughts.

 

If they're currently 'marking prices down' 50% on most items.  They might find it's possible to get the same number of unit sales by pricing the item at 45% off and 5% points back.  Or maybe 40% off and 15% points back.  Let's look at these examples, and their affect on margin/profit, in the case of an item priced 'originally' at $100.  Sometimes it doesn't look like you're raising the price when you actually are. 

 

Case 1  50% off: 

$100 item

50% off =

$50 paid for item

 

 

Case 2  45% off and 5% Points: (Note how this looks identical to 50% off for many/most people...see notes at bottom)

$100 item

45% off = $55

5% points = $2.75 in points.

$52.25 paid for item

 

 

Case 3 40% off and 15% in Points (looks like 55% off):

$100 item

40% off = $60

15% Points = $9 in points.

$51 paid for item (actually $60 paid in cash and $9 in points paid back)

 

Case 2 looks identical to Case 1 (the straight 50% off) to many people.  Particularly those that see value in SYW points.

 

Case 3 looks better than both other cases to many people (40% + 15% implies 55% off!).  But, we see that it's actually more profitable for SHLD than Case 1.  More profitable by $1, which is ~2% margin in our case. 

 

Plus!  Issuing points to members is very helpful for future sales.  Once people have points in their account they're a near guarantee to shop at SHLD in the next year, which reduces the burden on marketing (TV, Ads, etc.) to get the shoppers back into the store.  Marketing expenses might be greatly reduced a la Costco.

 

I think the examples above show for themselves, so I won't go on, but remember that people are not very good at mental math with percentages, etc. which SHLD might be able to exploit better than other retailers that are using straight coupons, etc.  See below.

 

-----

Note: Most people are bad with quick math when there is an obvious answer.  Obvious does not mean it is correct.  If you've read Montier's book on behavioral investing you'll be familiar with this 3 question MIT test.  Take a look at the three questions in the blog link below (not my blog) and it will remind us of how bad people are with math done 'on the fly', such as math performed by shoppers in a mall.

http://www.isaco.co.uk/blog/bid/143528/Behavioural-Investing-Try-the-3-question-MIT-test

 

[ni-co]

He came out and said it directly, why should we not believe him? Gross margin can't go up if you don't get people to pay more for the same product (I am assuming wholesale costs are unchanged).

 

Yes. You're right, but he also says on slide 22 of the presentation: "As model evolves, expect points to be substitute for PMDs, resulting in improved margin rate". He wants to replace PMD by points. What I don't understand is how this substitution is going to improve gross margin. Maybe, the membership discounts are more effective?

 

That's exactly the quote I was referencing in my original post. He is saying gross margins are depressed now because they are using traditional markdowns to drive sales, and then giving points on top of that. Essentially two promotions. Over time he will cut back on the markdowns, hoping that points awards/redemptions will drive sales. The customer ends up paying a bit more (because they value the relationship experience) and gross margin goes up.

 

I see. Sounds reasonable to me, though. Yet, I admit that there is a considerable risk that cutting back traditional markdowns won't work.

[Luke 532]

 

Note: Most people are bad with quick math when there is an obvious answer.  Obvious does not mean it is correct.  If you've read Montier's book on behavioral investing you'll be familiar with this 3 question MIT test.  Take a look at the three questions in the blog link below (not my blog) and it will remind us of how bad people are with math done 'on the fly', such as math performed by shoppers in a mall.

http://www.isaco.co.uk/blog/bid/143528/Behavioural-Investing-Try-the-3-question-MIT-test

 

I've always loved that book.  It's one of the two books I recommend to would-be value investors trying to learn the craft.

[ni-co]

Case 3 looks better than both other cases to many people (40% + 15% implies 55% off!).  But, we see that it's actually more profitable for SHLD than Case 1.  More profitable by $1, which is ~2% margin in our case. 

 

Plus!  Issuing points to members is very helpful for future sales.  Once people have points in their account they're a near guarantee to shop at SHLD in the next year, which reduces the burden on marketing (TV, Ads, etc.) to get the shoppers back into the store.  Marketing expenses might be greatly reduced a la Costco.

 

I think the examples above show for themselves, so I won't go on, but remember that people are not very good at mental math with percentages, etc. which SHLD might be able to exploit better than other retailers that are using straight coupons, etc.  See below.

 

Thanks, BTShine, that's a nice example!

 

 

-----

Note: Most people are bad with quick math when there is an obvious answer.  Obvious does not mean it is correct.  If you've read Montier's book on behavioral investing you'll be familiar with this 3 question MIT test.  Take a look at the three questions in the blog link below (not my blog) and it will remind us of how bad people are with math done 'on the fly', such as math performed by shoppers in a mall.

http://www.isaco.co.uk/blog/bid/143528/Behavioural-Investing-Try-the-3-question-MIT-test

 

I'm going to read it. You can also read these kinds of examples in Kahneman's really, really excellent book "Thinking, Fast and Slow".

[BTShine]

You can also read these kinds of examples in Kahneman's really, really excellent book "Thinking, Fast and Slow".

 

Thanks, that book is another great example.

[BTShine]

same ole same ole. nothing in here that addresses the losses in the retail business.

 

Respectfully disagree.  I hear them saying, based upon their testing and logical rollout of SYW, that they will be able to be profitable once the transformation is complete.  You can say "Eddie has been wrong before," and you'll be right.  So, maybe it's just a matter of if you believe his judgement is more likely to be right than not. 

 

From the call - "We are working in a very focused and diligent manner to drive this

transformation to a member-centric model and achieve improved levels of

profit performance."

 

"We’re becoming a more fact-based company and are making decisions based

on analytical data as opposed to gut feelings"

 

same stuff he's been saying for years. "transformation". except in 2013 the losses in retail were staggering. in the holiday quarter he barely made any ebitda. and land's end will probably trade closer to 10x than 15. 5 or 6 x ebitda. btw I hope you're right. I would love to become unburied in my shld.

 

Wellmont,

 

You sound like a bear.  But, it looks like you own shares, or are short puts. Is this the case?  I'm confused.  Why don't you just exit at a loss instead of losing more (if you believe it will go down/get worse from here)?

[Guest wellmont]

I hope I am sounding realistic. I mean the facts speak for themselves. It was a horrible year for shld retail. The company does not even make money at the Adjusted ebitda level, let alone at the net income line. apparently some of you number crunchers see this as the bottom. I hope so because my net worth will improve if it is. As for selling now, I plan on waiting for the short squeeze.  ;D

[PLynchJr]

Am I the only one who wants to puke every time I read "member centric business model" and "creating lasting relationships with members by empowering them to manage their lives"?

[vinod1]

Am I the only one who wants to puke every time I read "member centric business model" and "creating lasting relationships with members by empowering them to manage their lives"?

 

+1

 

In 2013, Christmas Day fell on Wednesday. Most retailers—us included—couldn’t promise in-time delivery of gifts purchased online the weekend before Christmas. Amazon, however, let customers order up through 11 p.m. Monday for in-time delivery.

 

Then some of the gifts didn’t get there before Christmas. Why they didn’t get there doesn’t matter as much as the fact that they didn’t.

 

The fact that many of us are not generating enough profit to meet the needs and expectations of our associates and our shareholders doesn’t really matter to customers.

 

The fact that the industry as a whole has failed to keep the promises it made to those customers matters a lot.

 

Worse, it puts all of retail into a broader context of failing to meet consumers’ expectations.

 

You have to admire the chutzpah!

 

Vinod

[Luke 532]

Well, I found a bright spot on the retail side. I've been tracking selling/administrative costs as a % of revenue because this integrated retail business model is supposed to drive cost efficiencies and Eddie is laser-focused on costs anyway. Amazingly, S&A had actually risen 6 years in a row since the Sears/Kmart merger at Sears Domestic and 5 out of 6 years at Kmart. I found this to be telling. Kmart's S&A went up again in 2013, but Sears Domestic's finally went down. See the attached chart.

 

Wouldn't improving comps in January and positive comps in February 2014 also be another bright spot?  I'm certainly not counting on Sears retail to be profitable ever again, but I don't think a successful retail operation is as far-fetched as some make it out to be.

 

http://searsholdings.com/invest/docs/2013_Q4_Call_transcript.pdf

“So we did see an improvement in our comp sales through the month of January. While still early in the quarter, we are seeing positive domestic comparable store sales for the month of February for Sears’ full-line and Kmart formats combined.”

 

[peridotcapital]

Well, I found a bright spot on the retail side. I've been tracking selling/administrative costs as a % of revenue because this integrated retail business model is supposed to drive cost efficiencies and Eddie is laser-focused on costs anyway. Amazingly, S&A had actually risen 6 years in a row since the Sears/Kmart merger at Sears Domestic and 5 out of 6 years at Kmart. I found this to be telling. Kmart's S&A went up again in 2013, but Sears Domestic's finally went down. See the attached chart.

 

Wouldn't improving comps in January and positive comps in February 2014 also be another bright spot?  I'm certainly not counting on Sears retail to be profitable ever again, but I don't think a successful retail operation is as far-fetched as some make it out to be.

 

http://searsholdings.com/invest/docs/2013_Q4_Call_transcript.pdf

“So we did see an improvement in our comp sales through the month of January. While still early in the quarter, we are seeing positive domestic comparable store sales for the month of February for Sears’ full-line and Kmart formats combined.”

 

I guess it would depend how important comps were to you. I care far more about margins because they dictate cash flow. If you are driving better comps through increased promotions (and therefore more sales are not leading to more profit), is that good or bad? Depends on what metrics you are focused on. I would also want to know what comps were last February... if they were good then it would be a better sign vs lapping a bad year-over-year period. I don't think it's enough information to draw a conclusion...

[adesigar]

I felt that Letter/Presentation/Conference Call was meh. Very little new information.

 

The few things I got were

1. SYW Points difference between 2012 and 2013 - $282 Million. That's the difference so actual cost is probably much higher. Even if the change was 50% increase over 2012 that means total cost of points is $846 Million (My estimate was $800 Million). 2 promotional programs. Once they see the points working they plan to go from fixed promotional cost using advertising to a variable cost using points.

 

2. Lands end separation by end of April

 

3. Nice reduction in pension obligations (which we kind of knew already). If they keep up current pace of contributions and interest rate increases about 1% in the next 2 years, Pension obligations will be gone.

 

4. Been reducing lease obligations significantly for last 6 years, Lease obligations down by 3 Billion in 6 years. The list of store closures reported this year will mean more reductions in these obligations.

 

5. They've expensed hundreds of millions in SYW points in Q4 which will be redeemed in next 3 Quarters resulting in increased sales if points are used or if unused will get cancelled out increasing earnings for Q1-Q3.

 

6. No shares repurchased.  :(

 

         

 

[T-bone1]

I think everyone needs to realize that this isn't the same thing as running a textile mill.  Perceptions and particularly headlines matter.

 

Many people on this board seem to desperately want Lampert to get on a call and say "We are slowly shutting down retail, allocating capital here, here and here, and now I'll take questions for an hour"

 

People need to realize that this would result in disastrous headlines like "Sears gives up on retail" and "Sears shutting down" which would have a terrible effect on both customers and employees.  This would materially damage the value of the business and make Lampert's job harder.

 

I am happy with what he is doing, not what he is saying - and he has plenty of skin in the game.  Look at what happened to JCP when they lost their core customers . . . how much will it cost - if it is even possible - to get them all back?  How much has it cost them so far?  Lampert has decided to simply hold on to these customers and even draw them closer with shop-your-way.

 

For him to take questions on the call, or say anything other than "we are 100% focused on becoming the best member-centric retailer in America" would be downright stupid.  He would get a ton of bad press that would result in losing his best employees and hurting the image of the retailers with customers.  Taking questions on the call would result in the same thing (unless he was totally evasive, which isn't good either).

 

I realize many (like myself) own the stock and some are frustrated, but I would really encourage people to look at what he is doing and not what he is saying if they want to understand the future of this company.

 

He is saying he wants to be the best member-centric, web based, employee loved, futuristic retailer of the next 500 years.

 

What he is doing is rapidly closing stores, redeveloping (downsizing and re-leasing space in) his best locations, selling off inventory, and permanently moving out of unprofitable retail segments.  He is cleaning up the balance sheet and posting very conservative numbers while he does this. 

[peridotcapital]

I realize many (like myself) own the stock and some are frustrated, but I would really encourage people to look at what he is doing and not what he is saying if they want to understand the future of this company.

 

He is saying he wants to be the best member-centric, web based, employee loved, futuristic retailer of the next 500 years.

 

What he is doing is rapidly closing stores, redeveloping (downsizing and re-leasing space in) his best locations, selling off inventory, and permanently moving out of unprofitable retail segments.  He is cleaning up the balance sheet and posting very conservative numbers while he does this.

If he truly is saying one thing publicly (we're focused on a retail transformation for the digital age) but not really thinking that internally (slowly liquidating the retail stores to maximize the value of those legacy assets), then why on earth monetize profitable assets like Lands End and reinvest that money into the retail operation? I can understand not announcing that you want out of the retail business to the whole world, but investing billions of dollars of precious cash into something that (if your hunch is correct), he doesn't really truly believe will earn solid returns in the future is what makes little sense in the scenario you laid out. Why not allocate that capital elsewhere? He's literally getting $500M in cash from Lands End and turning around and giving it out to SYW members. If he didn't believe in his retail vision, why would he do that?

[texual]

He still has to have a viable retail solution before investing it somewhere else. God forbid he makes a investment mistake with that cash? What if he makes a grand slam home run on investing the 500 million in stocks. What then? The retail just gets sicker. People will blame him for being a hedge fund manager who didn't pay enough attention to the company.

 

What if he loses the 500 million on those investments? People will say he should have done better for his company before his shareholders.

 

No matter how you slice it ESL has to have a viable, downsized, and retail centric focus for as long as it takes (10+ years and counting) before he can either give up completely, or start investing elsewhere.

 

I personally didn't see it taking this long which upsets me that I too, could have invested elsewhere. But consider how delicate that balance is. A CEO who runs money elsewhere can be construed as genius by us, and a real jerk by everyone else. It's a good thing WEB didn't have such a consumer facing brand such as Sears and Kmart that could have ruined him had he invested elsewhere while the main core was declining and upsetting the country.

 

Headlines matter. ESL knows it, but he can't do anything except play the retail game. He's closing stores, hes investing in the redevelopment of the real estate slowly, he is putting a focus on internet sales, he isn't going to buy BAC shares right now. I know it kind of sucks that he HAS to do all this stuff first. I'm only realizing this right now. He kind of has to save Sears before he can save himself, and us.

 

Shareholders don't come first in this situation, since the retailer is struggling. It gives him time to either build this company into a better one, or to let it basically fail no matter what he does. At some point in time we will know he is at the endgame. 2014 will tell us a lot. 2015 will be a big decision making period if things don't improve. I wish his SYW program turns into a hit, or that he closes even more stores, like 2 a day for the rest of the year. I wish Lands' End made us really rich in the interim. I have no idea what will happen but there isn't a doubt in my mind that he is only doing what he can with what he has to work with.

 

He would be buying back shares hand over fist, but he doesn't want that to be another point of contention with everyone who already blamed him for buying back too much/too high.

[Liberty]

Very insightful posts, textual and t-bone.

 

Makes me even less interested in SHLD for the long term since retail will likely keep ESL handcuffed for a long long time.

[T-bone1]

I realize many (like myself) own the stock and some are frustrated, but I would really encourage people to look at what he is doing and not what he is saying if they want to understand the future of this company.

 

He is saying he wants to be the best member-centric, web based, employee loved, futuristic retailer of the next 500 years.

 

What he is doing is rapidly closing stores, redeveloping (downsizing and re-leasing space in) his best locations, selling off inventory, and permanently moving out of unprofitable retail segments.  He is cleaning up the balance sheet and posting very conservative numbers while he does this.

If he truly is saying one thing publicly (we're focused on a retail transformation for the digital age) but not really thinking that internally (slowly liquidating the retail stores to maximize the value of those legacy assets), then why on earth monetize profitable assets like Lands End and reinvest that money into the retail operation? I can understand not announcing that you want out of the retail business to the whole world, but investing billions of dollars of precious cash into something that (if your hunch is correct), he doesn't really truly believe will earn solid returns in the future is what makes little sense in the scenario you laid out. Why not allocate that capital elsewhere? He's literally getting $500M in cash from Lands End and turning around and giving it out to SYW members. If he didn't believe in his retail vision, why would he do that?

 

The business needs less inventory each year as he downsizes the retail operations.

 

I think people have the perception that he is burning $1 billion in cash ever year keeping the retailing businesses alive. 

 

Is it possible that a large portion of these losses is selling excess inventory (that most people value at zero) for less than the carrying value?

 

I don't believe that the retailer will burn any cash going forward.  Perhaps I am in the minority, but I believe the losses are overblown.  Certainly this has not been a profitable activity for the last few years, but some portion of the losses have actually been turning excess inventory into cash (which is good!), and Eddie is making it look worse than it is (immediately expensing SYW points).

 

If you look at the losses of this year, and subtract GAAP losses on selling excess inventory at a discount, then discount the actual expense of giving out SYW points, then take away the lease expense and operating losses from the 200 worst stores (which he is rapidly closing), how much money is he really "throwing at" the retail operations?

[jazzmasterg]

I'm interested to watch ESL's actions after the Land's End shares spin off. My assumption is that he has plenty of redemptions to meet, and/or that he probably sees SHLD as undervalued, so the LE shares will be sold fairly quickly...

 

But, ESL has clearly had some experience investing in retail (Gap, AN, AZO, etc), and he's had some success with it. So after the Land's End spin, what does he do with his shares? Does he have any reason/desire to hang on to them?

[Mephistopheles]

Am I the only one who wants to puke every time I read "member centric business model" and "creating lasting relationships with members by empowering them to manage their lives"?

 

Honest to God, I was thinking the exact same thing today. I couldn't even get through the conference call without feeling nauseous.