Dueling Fools
Shears to Sears
January 6, 1999

Sears Bear's Den
by Warren Gump ([email protected])

Is there a merry side of Sears?

To find the merry side of Sears, I would propose that investors take their money out of Sears stock and place it in companies in the similar industries that have brighter prospects than this retailing dinosaur. This company, which has tried to reinvent itself to become relevant in the lives of customers, appears to have been unsuccessful at the task. Competitors from all sides are nipping at the company's bread and butter businesses. A repositioning program started several years ago showed initial success, but now appears to be faltering. The company must now once again figure out how to remake itself.

With the arrival of Arthur Martinez as Chairman of the retail merchandise group in the early 1990s, Sears began a process that did actually create quite a bit of value. Having accumulated such disparate businesses as Dean Witter, Coldwell Banker, Allstate Insurance, and Homart Development, Sears decided that it would be best to divest those businesses to focus on its core retailing concepts. Between 1993 and 1995, the company completed these transactions. Freed from the albatross of the Sears organization, Dean Witter, which is now Morgan Stanley Dean Witter & Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MWD)") else Response.Write("(NYSE: MWD)") end if %> and Allstate Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALL)") else Response.Write("(NYSE: ALL)") end if %> have had successful incarnations as public companies.

In 1993, the company also inaugurated a five-year, $4 billion plan to upgrade its store base. This plan is now essentially complete and the results are somewhat disappointing. The repositioning, which brought in much better merchandising and product selection in soft goods, increased sales strongly at first. Unfortunately, however, the boost has not been sustainable. In 1996, same store sales increased a rather healthy 5.8%, but results for 1997 were a more tepid 2.3% increase. For the first 43 weeks of this fiscal year, same store sales have only inched up 1.1%. The company is losing momentum fast.

What is the problem? The company has lost focus on its customers. While the Sears certainly has a strong reputation in hard goods such as appliances, auto service, and electronics, its move to offer fashion apparel is somewhat perplexing to customers. In addition, competitors have come in with better mousetraps. Companies such as Best Buy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBY)") else Response.Write("(NYSE: BBY)") end if %> and Circuit City <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CC)") else Response.Write("(NYSE: CC)") end if %> offer better prices and wider selections on appliances and electronics. Home repair superstores such as Home Depot <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %> and Lowes <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LOW)") else Response.Write("(NYSE: LOW)") end if %> do the same for tools and home repair services.

As to fashion apparel, it doesn't seem that Sears really has figured out how to market its "softer side." There is no doubt that the stores look much better than they did years ago, but the competition has also improved. Sears has not been able to obtain many of the designer fashions that are available at many department stores like Macy's or Hecht's. At the lower end of the spectrum, Sears has many offerings, but they are not as fashionable or inexpensive as offerings from discount retailers Target or T. J. Maxx <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TJX)") else Response.Write("(NYSE: TJX)") end if %>.

What about the company's move into the high-margin cosmetic business? The company introduced its "Circle of Beauty" concept into stores to attract prestige fragrance brands. It hoped that the section would bring in revenue of over $125 million. According to a recent report, the concept currently has sales of less than $70 million. It is now repositioning itself by including lower prices and more "values" such as $15 bundles. Those changes will certainly not enhance the company's standing with prestige brands.

The company pursued opportunities for growth in retailing, but Sears appears not to be up to the task. It has tried to develop "off-the-mall" furniture, auto parts, and hardware stores to better compete with specialty stores that have become preferred by consumers. It has recently, however, been divesting those operations because of lower-than-expected returns. In November, the company agreed to sell its Homelife stores to Citicorp Venture Capital Ltd. In August, the company reached an agreement to merge its Western Auto chain with Advance Auto Parts. This transaction will provide Sears with a major ownership stake in Advance, while letting Western Auto stores be operated by a (hopefully) better management team than Sears can provide.

The one hidden gem in Sears portfolio is its credit card operation. Reports indicate that this division provides about half of the company's profits. Unfortunately, this division has been undergoing hard times. The percentage of delinquencies rose almost 75% from 4.2% in 1995 to 7.0% in 1997. This has resulted in soaring expenses for charge-offs. To combat this problem, the company has to tighten its credit standards (possibly hampering sales). The company also had to fight a battle last year regarding its handling of customers who filed for personal bankruptcy. In the end, it took a $475 million charge to settle claims related to this issue. Looking toward the future, profitability for the credit card division could be hampered by slowing sales at the retail stores since 90% of receivables are derived from the Sears card.

My investing style tends to be value oriented. From traditional valuation metrics, Sears certainly falls into the value category. For a value stock to be a successful investment, however, it must have a catalyst for future growth. Given that less-than-stellar performance of its recent remodeling program and restructuring efforts, I don't see a merry side to Sears' future. Over the next couple of years, the company will probably announce another remodeling/repositioning strategy. Billions of dollars will again be spent to revitalize the brand. There might be another short-term boost to performance, but based on this past repositioning it is unlikely to be successful in the long run.

Unless the company can develop a strategy that truly differentiates itself and provides value to customers, Sears' role as a major U.S. retailer will continue to diminish. The company needs to reinvent itself in a way that creates a sustainable competitive advantage. Recent efforts haven't proven to be successful. The company has too much baggage with old stores and a stodgy perception among the public. Over the past decade, many competitors have developed concepts that are more effective in serving the customers Sears targets. The company appears to be headed into the heap of "glorious retailers of yesteryear." Remember Woolworth? Once a major retailer included in the DJIA, now it's struggling as Venator Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: Z)") else Response.Write("(NYSE: Z)") end if %> because it didn't successfully adapt to changes in retailing. Sears could be next.