BLOG: RIP, Sears?
CHICAGO (Oct. 3, 2014) — Only two more years for Sears? That projected time of death surprised even those of us who see little long-term hope for the money-losing retailer.
But that's essentially what credit ratings service Fitch Ratings meant when it said recently that Sears Holdings Corp.'s “funding options may not be enough to support operations beyond 2016.” The warning came as Fitch downgraded the company's debt to “CC,” a junk-level rating that means “default of some kind appears probable.”
Until now, Sears watchers have focused on 2018 as the likely reckoning point for the Hoffman Estates, Ill.-based retailer, which has been desperately selling off pieces of itself to cover rising losses. That's when big chunks of debt come due for Sears, which last year floated the idea of divesting its Sears Auto Center and Lands' End businesses as part of a strategy to “improve our financial flexibility and accelerate our transformation into a leading 'integrated retailer.”
But Fitch is the first to go on record as believing the end is nearer. Of course, a lot of variables will determine if and when Sears might have to take shelter in Chapter 11 bankruptcy protection. What's interesting isn't so much the chronological accuracy of Fitch's forecast as its willingness to put an expiration date on the 121-year-old company.
As a credit rating agency relied upon by investors in corporate debt, Fitch is obliged to call it like it sees it. Sometimes that means squarely addressing the likelihood and probable timing of a bankruptcy filing. Hence the statement that “Fitch expects that the risk of restructuring is high over the next 24 months.” In credit-market speak “restructuring” means “Chapter 11.”
In an emailed statement, a Sears spokesman said: “We don't agree with their action, given our demonstrated history of honoring our financial commitments while continuing to invest in our transformation.”
Fitch's conclusions are grounded in an analysis of the challenge Sears faces in raising enough cash to cover its operating expenses and other obligations between now and the end of 2016.
Sears' woebegone store operations are consuming roughly $1 billion to $1.5 billion in cash annually. On top of that, Fitch figures Sears needs about another $1 billion a year to cover interest on its debt, maintain its stores and pay legally required contributions to its pension plan.
The retailer has tried to tamp down worries by reciting a list of potential cash sources. Execs say it could sell off its stake in Sears Canada and maybe the Sears Auto Centers. It also could tap the value of its real estate by selling or mortgaging more stores. Altogether, Sears estimates it could raise $5.2 billion in cash.
(The Associated Press reported on Oct. 2 that Sears — sorely in need of cash — is selling most of its stake in its Canadian unit in an effort to raise up to $380 million. The sale of the majority of its 51-percent stake in Sears Canada Inc. to its own shareholders will, according to the AP story, “give the retailer some breathing room as it heads into the crucial holiday season.”)
Still, Fitch concludes Sears won't have enough cash to make it past 2016. Fitch estimates the retail chain will burn $2 billion or more in cash annually between 2014 and 2016, for a total of $6 billion.
“We're saying that even if they can do all this, we're still talking about two or three more years,” said Fitch Senior Director Monica Aggarwal, the company's primary analyst on Sears.
And doing all that will take some doing. Sears' estimate of its cash-raising potential is a trifle optimistic.
Take Sears Canada. Sears Holdings' 51-percent stake in that operation is worth about $830 million, based on the Canadian company's stock market value. But Sears can't just sell those shares on the open market — doing so would tank the stock price. It has to find somebody willing to buy its whole stake. But who wants to pay full prices for a majority stake of a foundering Canadian department store chain?
Estimating the sale value of the auto centers is difficult because Sears doesn't disclose the unit's profit. But auto center sales declined in the second quarter, according to Sears's most recent quarterly report.
Then there's Sears' revolving credit line. True, the revolver provides for up to $3.28 billion in borrowing. But there's less there than meets the eye. Outstanding balances and borrowing restrictions written into the deal had reduced availability under the line to $240 million as of Aug. 2, according to the company's quarterly filing with the Securities and Exchange Commission. That number will rise as Sears adds inventory in advance of the holiday selling season but drop again when inventory reductions resume.
When it comes to real estate, remember that the value of retail real estate in a sale or as collateral for a loan hinges on the viability of the retailer occupying the stores. With Sears closing stores left and right, how much value will a buyer or lender see in its real estate?
All of this underscores the reality that hocking or selling off assets to keep afloat is a losing battle. As Fitch noted, Sears's core problem is declining sales, which causes deeper losses even as the company shuts down its worst-performing stores.
Maybe Sears will scrape together enough cash to cover its expenses a little beyond 2016. Cash consumption at its stores may slow, asset sales may fetch more than expected, lenders may advance a few more dollars.
But one of the conclusions I draw from Fitch's analysis is that Sears will be pretty well out of options if sales haven't picked up enough to cover operating expenses by then.
A company that's still burning cash after tapping out its credit sources and unloading all its salable assets doesn't have much of a future.
This blog opinion piece recently appeared on crainschicago.com, the website of Crain's Chicago Business magazine, a sister publication of Tire Business.
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