Michael Santoli

Sears Grows on the Web – but Can It Shrink Fast Enough Offline?

Michael Santoli

After nearly a century on Main Streets and decades at the mall, Sears would now prefer its customers approach using a browser – or even through another store chain – rather than through its own doors.

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Associated Press

As Sears Holdings Inc. (SHLD) continues to struggle with sagging sales at its more than 2,000 Sears and Kmart locations, the company is trying to shrink its physical presence through store sales and closures while corralling as many of its core customers as possible into an online community attracted to membership-rewards discounts.

Based on the company’s latest results – including a wider-than-expected second-quarter loss on declining same-store sales – some progress has been made but it’s far from clear whether the storied retailer and its CEO and controlling shareholder Edward Lampert can pull off this transition neatly.

The market has been and remains skeptical, its shares dropping more than 8% Thursday to below $40 (before being caught up in the midday halt of all Nasdaq trades amid tech issues), and with more than 50% of the available public shares sold short by those betting on further price declines.

The Kmart struggle

Kmart continues to struggle, with poorer locations and higher prices than discount competitors such as Walmart Stores Inc. (WMT), while Sears remains heavily exposed to sales of tools and appliances (though clothing sales were up on a same-store basis for the eighth straight quarter).

Online revenue, though, rose 20% from a year earlier, and the “Shop Your Way” loyalty program aggressively marketed by Sears has borne fruit. Last quarter 65% of sales came from members.

Somewhat surprisingly, Sears was ranked 8th out of 100 big e-commerce players by Web-research group Baymard Institute for the quality of its online-shopping “checkout experience,” ahead of such marketing heavyweights as Victoria’s Secret, Target (TGT) and Gap (GPS). Sears has for several years owned the apparel and outdoor-gear catalog-and-Internet retailer Lands End, which in December was ranked second in online customer satisfaction by J.D. Power & Associates. Meantime, breaking with a long policy of keeping its strongest brands exclusive to Sears, the company now sells flagship Kenmore appliances and Craftsman tools via such third-party outlets as Costco (COST) and Ace Hardware.

Says one hedge-fund manager who has owned the stock for a few years and thinks the sum-of-parts value is well above today’s share price, “It certainly appears the whole strategy here is built around creating a viable retailer with a primarily online-based customer engagement platform.”

The trick is to keep the retailer viable as it sells off stores, services its pension obligations and focuses on opportunities to broaden the market for its core brands.

The Lampert strategy

In recent years, Lampert, who made his fortune as a hedge-fund manager, has been running Sears much as a private-equity firm would treat its portfolio – as a collection of discrete assets, rather than a pure retailer with an organic-growth strategy. Indeed, Lampert explicitly argued against standard retail-industry norms for spending on store maintenance and physical upgrades.

The tattered, untidy look of many locations, especially in comparison to big-box rivals such as Home Depot Inc. (HD) and Target Corp. (TGT), helped give the chain its reputation as perhaps America’s most-hated big company.

Lampert has spun off Sears Hometown and Outlet Stores Inc. (SHOS) and Sears Canada Inc. (SEARF); bundled Kenmore, Crafstman and Die Hard brands into a specially formed entity that can collect royalties; explored the sale of Sears warranty business and has $170 million left to go on a planned $500 million in real estate and other asset sales.

Lands End, which has always been operated largely independently, is commonly mentioned as a coveted asset that, in theory, could be sold. That now represents a big chunk of Sears $4.2 billion stock-market value.

All the while, Lampert has worked to ensure the company stays liquid enough to absorb a tough sales environment and service its debt and pension liabilities. The company as of Aug. 3 has $681 million in cash and the ability to draw another $1.6 billion on its bank credit lines. It was also sitting on $4.8 billion in inventory (net of the cost of goods in inventory). It faces no significant debt maturities until 2018, and its required pension contributions have come down substantially compared to the past few years.

All of which is to say, Lampert still has a financial cushion that should give him time to keep Sears getting physically smaller, while promoting its online customer-outreach efforts and exploiting the value of its strong brands. The trouble is that this has been the case for years, and there seems not to be an appetite for shopworn Sears or Kmart off-mall locations or even many of its mall-anchor boxes. The country remains “over-stored,” especially in many older downtowns and aging malls.

Sure, here and there Sears real estate has been converted to parking lots or mixed-use space, but not yet enough to make a big dent in the 2,000-plus store base.

Lampert, it should be said, has consistently put his money behind his grand plan, personally acquiring shares in recent years to lift his ownership above 55%. This has thus far failed to inspire broad confidence in the viability of Sears's strategy among investors, who for now are content to resist the heavily marked-down stock.

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