Sunday, September 16, 2018

Sears is dying because of—Pensions? I don’t think so.

Sears is dying because of—Pensions? I don’t think so.
On September 13, 2018, Edward Lampert, CEO of Sears Holdings, said in the Sears Holdings blog:

In addition to the very difficult retail environment, Sears has also been significantly impacted by itslong-term pension obligations(emphasis mine).In the last five years, we contributed almost $2 billion, and since 2005 we have contributed over $4.5 billion, to fund our Pension Plans. (

He also said:

Like many other brick and mortar retailers, Sears has encountered very substantial obstacles to profitability as a result of the enormous changes to the retail environment caused by the ever-increasing trend to online shopping. 

The second statement is clearly true. The first one is an excuse for bad marketing and merchandising. My view is that failure to reinvent themselves and become relevant in the current retail environment- online shopping or not- is why Sears is dying, not pension costs.To support this thesis, let’s compare Sears to another mass merchant who faced the same brick and mortar challenges that Sears did-Target. Go into a Target store today and you see tangible evidence of what they have done to face the changing retail landscape--neat and clean stocks, private brands that look much better than mass market, etc.- at Sears there is no such evidence (remember the Sears Holdings group also includes Kmart). 

That being said, Sears has some iconic private brands such as Kenmore, Craftsman and DieHard, which should have led the pack. In apparel, there is little private brand development, Sears and Kmart relying (except, notably, for Joe Boxer, which they ruined as a brand) on national brands which can be bought anywhere).

Let’s go back to 2005 and compare with today for both retailers in several key financial and market elements that would tell the story.

First, market capitalization and share price:

Market cap ($Billion)
Market cap ($Billion)
Difference ($Billion)

Share Price ($)
Share Price ($)
Difference (%)

(Sources: Seeking Alphaand Macrotrends.netsame for all below)

So, in 2007, Sears share price was more than double Target’s. Market cap substantial. Share price is the interpretation of value creation by investors and market cap is the number of shares x share price. Share price may be inflated by limiting shares; that being said, it is still an indication of  who wants your shares. Doing the math, Sears outstanding shares in 2007 171.6 million; today 108 million. Target, on the other hand, 670 million in 2007 versus 526.5 today. Yet the value per share is substantially higher.

Let’s look inside the financial statements of both companies. Heavy pension obligations would have significantly impacted Sears SG&A. Let’s take a comparative look at both companies at key points in time:

SG&A % at (date)

Until the current number, I don’t see a disastrous difference between the two. Do you?

Let’s dig deeper. To get to the bottom line, we must first look at the Gross Margin % line for both:

GM % at (date)

Overall, Target has done a much better job of managing GM (which has nothing to do with pensions). As we know, GM is a function of initial markup AND markdowns due to bad merchandising decisions on quantity or style or both.

We should next look at revenue for both companies:

Revenues ($B at date)

(The big jump for Sears between 2005 and 2007 would be due to the merger with Kmart which created Sears Holdings.)

Now, the picture becomes clearer! Notice that in 2007 Sears and Target were in the same ballpark. Then the divergence begins-Target has grown continually, albeit not dramatically, while Sears has—tanked. So the main financial thesis is this: Sales and Gross Margin (discuss reasons later) were the reasons for Sears decline; blaming it on pensions is an excuse (which got a lot of press).

If we look back at SG&A for both retailers for the last ten years, we can see no dramatic difference (until today). Expenses are slower to impact for a retailer of this size than sales and gross margin-which is impacted by merchandising and marketing.We also know the concept of profit flow through—incremental sales which do not directly cause additional expense flow directly to the bottom line.
Clearly Target has had its struggles, well documented, as Sears, but the difference is that they managed to remain relevant and grow the business. Why?

Before we answer that, let’s look at two who did really well during that period—Walmart and TJX. Walmart has made a big push into online business, TJX none; both remain key brick and mortar retailers. Let’s take a look at some numbers:

Revenue 2005 ($B)
Revenue 2018 ($B)
GM% 2005
GM% 2018
SG&A% 2005
SG&A% 2018

So- Somewhat a tale of two retailers, but can help us reach a conclusion. Walmart GM% is less than Target or Sears, and their SG&A has grown 21% over the period despite sales almost doubling-ouch.

TJX, on the other hand, has improved GM% dramatically and managed SG&A well (only 6.5% growth—that being said, my principle would be that, if SG&A % doesn’t go down with that degree of sales increase, your expense control is sloppy at best. 

What is common to all is that they have had challenges putting a lid on SG&A, in some cases despite blistering increases in sales. Calculate for yourself the absolute difference in $ of Walmart’s SG&A from 2005 until now. So-Sears SG&A over the period seems no excuse.

Which leads us to the bottom line conclusion. In no part of the blog post does Edward Lampert mention merchandising, marketing, efforts (except to say they are seeking partners for existing brands). That is where the others have succeeded and Sears has failed-generating sales through relevant and timely merchandising and marketing. Nothing else really counts in retailing.

Let me be clear- I am sure Edward Lampert knows the above, better than me, because he faces the real numbers every day. BUT- while the pension obligations were unescapable and not much could be done about them, EVERYTHING can be done every day about merchandising and marketing. THAT is where Sears failed.

PROOF: What’s in a name? How to develop a brand—Kmart Australia, which originated there in 1968, shortly after the US version, is a blazing success. You can read all the media and annual reports online, but here is some information from an article published in 2016 entitled, “What’s in A Name: Kmart succeeds as Kmart depletes”:

Late of September last year Sears Holdings announced its plans to possibly close 204 US Kmart stores. The same time last year Wesfarmers Kmart in Australia boosted earnings by 16.3 percent. So why are two similar stores facing two very different financial outcomes?


Both stores came from the same founder in the 60's, deal directly with cheap value ranges, focus on quantity and easy accessibility items and even have similar logos. So how is one chain dominating the industry while the other one suffers a slow demise?

Among other things, but what I said:

Wesfarmers Kmart’s image is a bit different to Sears Holdings. It hints that it is still youthful and cool, even though it’s good value. Their ads are often full of vibrant people aged 18-22, exceedingly lithe and probably unlikely to be found at an actual Kmart.

Like Target.

Edward Lampert, with all due respect to your expertise and difficult job, what did I get wrong? It is nothing but distracting and misleading to even imply that, significantly (your word) your problems came from pensions and the difficult retail environment. 

(You may also want to read my previous article, “J.C. Penney and Sears—The Hollow Men-An American Tragedy”on my blog

Thursday, August 23, 2018

J.C. Penney and Sears: The Hollow Men- An American Tragedy

The story of J.C. Penney and Sears today reminds me of T.S. Eliot’s 1925 iconic poem, The Hollow Men.The last four lines of that poem read:

This is the way the world ends
This is the way the world ends
This is the way the world ends
Not with a bang but a whimper.

This story is nothing less than a Modern Tragedy. What happened? Perhaps the two most iconic retailers in the US, maybe the world, are slowly fading to nothing. Without fanfare, without noise. Both are almost gone, and more than probably will be soon. Yet, the retail scene in the US is the strongest and most dynamic in the world. 

Let’s take a real quick history tour and then look at the numbers. Numbers are the Single Version of The Truth.

First, J.C. Penney:
·     First store 1902
·     Renamed J.C. Penney 1913
·     1917-175 stores, 500 stores 1924, 1000 stores 1928.
·     1928 business $190Million (=$2.71 Billion 2018)
·     First Catalog 1963
·     1971 business $5Billion (=$30.2 Billion 2018)
·     First Internet Store 2001
·     2012 it was revealed the 30% of the company’s bandwidth was used for viewing YouTube videos- 1600 Heads rolled.
Next, Sears:
·     Started in 1892
·     Catalog 1906
·     1907 business $50 million ($1.3 billion 2018)
·     2004 bought by Kmart, became part of Sears Holdings).

Let’s look at key financial data:
J.C. Penney:
·     8/22/2008 Stock price $38.32 (9/12/2008 stock price $41.43)
·     8/22/2018 stock price $1.81 (Citi puts the fair value at $.50)
·     Market Cap=$547.5 Million (that is Million, not Billion)
·     Revenue $12.34 Billion (-$1.19%)
·     Cash $182 Million
·     Debt $4.22 Billion
·     8/22/2008 Stock Price $62.80 (5/4/2010 stock price $91.04)
·     8/22/2018 stock price $1.19 (no, I didn’t miss any digits)
·     Market Cap $133.2 Million
·     Revenue $15.29B (-27.34%)
·     Cash $466 Million
·     Debt $5.53 Billion

Wow. So where did all that business go? Here are a few places:

·     8/22/2008 Stock price $59.21
·     8/22/2018 Stock price $95.72
·     Market Cap $283.52 Billion
·     Revenue $510.16 Billion
·     Cash $15.84 Billion
·     Debt $53.80 Billion
·     8/22/2008 Stock price $52.66
·     8/22/2018 Stock price $85.88
·     Market Cap $44.39 Billion
·     Revenue $72.64 Billion
·     Cash $1.06 Billion
·     Debt $11.39 Billion (a lot, but still less than revenue OR Market Cap)
·     8/22/2008 Stock price $18.00
·     8/22/2018 Stock price $105.80
·     Market Cap $66.76 Billion
·     Revenue $36.77 Billion
·     Cash $3.12 Billion
·     Debt $2.23 Billion 
(This is a healthy company, folks)
·     8/22/2008 Stock price $20.13
·     8/22/2018 Stock price $37.69 (peak price 7/17/2015 $72.31)
·     Market Cap $11.74 Billion
·     Revenue $25.40 Billion
·     Cash $1.07 Billion
·     Debt $5.54 Billion
(This is a case who could have easily shared the same graveyard as JCP and Sears, but showed some fight. Not out of the eyes of the Grim Retail Reaper yet)
Saved the best for last:
·     8/22/2008 Stock price $85.28
·     8/22/2018 Stock price $1903.70
·     Market Cap $918 Billion
·     Revenue $208.13 Billion
·     Cash $27.76 Billion
·     Debt $45.79 Billion


So, 10 years ago JCP and Sears Stock price was higher than any of the others, except for Amazon. 

Today, any of the above could buy 100% of BOTH Sears and Penney’s stock for cash on hand. Not that you would want to.

What happened?

They lost their fastball. And their relevance. And their identity. But, most important, they managed THEMSELVES into oblivion.  A dear departed friend said, “The fish stinks from the head.” This is the case here. The management not only drained their moat but made it into a parking lot with free passes. Ten years ago, when they were on par or above the retailers that have eclipsed them today, they could have reinvented themselves and embraced the changes in retail-the retail experience, fast fashion, ecommerce, etc. (we all know what they are). IF they did that, their iconic name would have added extra weight to the effort. So who to blame? The buyers, store personnel? Maybe they hired the wrong people, or failed to hire the right people; maybe they lived in a bubble of denial. Any way you look at it, it is MANAGEMENT, who probably collected 7 figure salaries and bonuses as Rome burned. Hey, what if they all gave the money back?

Walk through a JCP or Sears store today and look at their apparel. You honestly cannot imagine in your worst nightmare who is the target customer.

Messiness and crowdedness are horrible, but not necessarily the issue. TJX stores are messy and crowded. But the merchandise is relevant, clearly. Walmart is a nightmare to shop in, but it has its customer convinced, that the price is worth the price of the nightmare.

Target has bridged the gap between mass merchant and fashion destination. Macy’s is trying to keep its level while discounting just about everything.

What these mass merchants like Target have figured out is: IF you can get the prices you need (which you can, see below), it costs the same to buy a tasteful, fashionable garment as an ugly one.

Example: I can buy a blended cotton/polyester mens dress shirt for $4.30 FOB China; with duties and transportation lands around $6.00-$6.25. So if I am not a hog on markup, I can sell a good looking shirt for under $15.

I wish I could have been a fly on the wall at Penney’s or Sears to see just how all that ugly merchandise got past the chief merchants and was put into production. Or maybe the chief merchants just sipped coffee and let the buyers do their thing? Sorry, the retailer in me will never go away. Like my former boss Mike Jeffries (at Federated), I look at something really ugly in the store and say, “ who could have chosen this?” Not hard. The above discount merchants like TJX and Target managed to give the customer fashion value. Clear: there is no price for ugly.

Still today, the only thing of value for both JCP and Sears today is their name. Their merchandise, and management could be scrapped with no loss. Just like Amazon did with Whole Foods (used to be called Whole Paycheck), someone clever could play the Sears or Penneys name into an iconic destination with an American Experience. So much history, and iconic imagery! I am sure of this, but the cost of doing so could be prohibitive.

At this point I only wish the two of them could have gone out according to Dylan Thomas 1947 poem, Do Not Go Gentle Into That Good Night. Here, the iconic verse is:

Do not go gentle into that good night.
Rage, rage against the dying of the light.

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