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Tracking the slow death of American icon Sears

Brian Sozzi, CEO and chief equities strategist at Belus Capital Advisors
Monday, 6 Jan 2014 | 12:49 PM ET

Back in the day of limited hardware/software technology, and information on the internet, stock analysts would pour over mounds of snail-mailed print documents from companies, take detailed handwritten notes from conversations with executives and sources, and then publish a bible for clients containing all of the must-know information found in three-months. But the role of the analyst is changing before our very eyes.

(Read more: Comparable sales at Sears US, Kmart plummet during holidays)

Trust me, these research bibles are still being produced by analysts upon coverage launches and specialized endeavors, say to assess values for clients on physical assets surrounding a 35-mile radius from a major public transportation hub.

However, the research game is now changing thanks to an abundance of real-time information from reputable industry sources on Twitter and Facebook, and consumers sharing credible gripes on their experiences with a company's products or services.

Sears Holdings Corp. signage
Victor J. Blue | Bloomberg | Getty Images
Sears Holdings Corp. signage

Hey, Lululemon's "SheerGate" didn't catch fire from the release of financial statements, it spread via the passionate blog scene. Information socially shared could be far-reaching, from Vine videos to Instagram pics with assigned special effects. I find it pretty interesting to see how the rapid progress in technology has allowed truthful stories to be told on public companies. Any stock analyst seeking to stay ahead of the curve with their recommendations needs to acknowledge the existence of this potentially impactful pool of streaming information in their decision-making process, as in my view it creates stronger investment theses for clients.

(Read more: It's not as gloomy as you think for retail)

Having covered sectors ranging from industrials to videogame-software publishers to retailers, serious fieldwork has always assumed a prominent position when I disclose a buy, sell or hold recommendation on a company's stock. Whether it's dissecting a new iPad to determine costs, or staring at shopper behaviors inside a JCPenney, pounding the pavement, so to speak, has given an added layer of understanding to the financials that are generated by a company every three months. The trick to what I have done through the years is to have the facts on a company in order to first and foremost support proprietary findings gleaned from the line of duty. This tried and true approach to investment research is what I have undertaken on Sears since 2009, and increasingly from October 2013.

The marriage of facts and visuals were apparently too much for Sears headquarters to digest. After tweeting out a series of photos on Saturday live from the field, which were picked up by TheStreet and subsequently went viral, the vice president of corporate communications for Sears Holding Corporation had this to say:


I have ALWAYS held myself to the highest ethical and professional standards in a decorated 11-year career in financial services. That, in combination with my forever positive and upbeat disposition, led me to disregard this hurtful, unprofessional statement from an individual who I have shared productive tweets with regarding Sears in the past. But, then came this tweet, which unleashed #beastmode because it's on the heels of Sears suggesting to sources that I am consulting for Macy's, a ludicrous completely false statement:

Everything I do in life, whether it's stock research or executive interviews for Men's Health magazine, is carefully planned months in advance, at its core rooted in helping people understand business and driving positive change. In fact, when our research on dilapidated Kmart stores went live in early November 2013, a couple weeks later we revisited the sample stores used and found everything we pointed out fixed. Kudos, Sears, for doing these store repairs. As far as I am concerned, a huge win for me, as it fostered a bunch of stores that were safer, and more inviting,for hard-working moms and dads to shop.

Poke the beast

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Following this exchange, I felt I had to release this public statement.

Now, I'm going to demonstrate, through Vine videos and photos, why Sears shares have plunged about 26 percent since the end of October, when we reiterated our "sell" recommendation on the stock. The footage may also shed light for you on the following subjects:

  • Why Sears shares are down more than 76 percent from their April 2007 all-time high
  • Why new photos I shared on my Twitter feed ( @BrianSozzi) on Jan. 4, 2014 went viral, and elicited pure outrage by the people (with @Sears copied in) that grew up visiting Sears and Kmart with their parents. In analyzing their passionate responses, I was left with an impression that Sears personally hurt them, as if the poor physical conditions and buying experiences at the majority of the store base were a kick to the face of the pleasant, simpler times of shopping the brands at their operational peaks as children.

Sears will be quick on the draw to respond to this research in the following manner:

  • "We are undergoing a transformation."
  • "Footage from 10 stores is not representative of our 2,000 store base."
  • "This is an analyst trying to boost his Klout score."

To these comments I am prepared to field, I would offer this:

  • I issue an open invitation to any member of the Sears executive team to walk 15 stores of my choice, stores outside of the Chicago and high-income markets that are not spruced up for social sharable photo ops … with cameras rolling.
  • The years of massive underinvestment in a majority of the stores overwhelms the few stores that are clean, bright, and cheery (but still not aesthetically competitive to Walmart and Target stores). As a result, a 10-store sample size is an indication of the shopping experience presented to consumers on a daily basis. I have the consumer comments to support this claim, the emotion in each response is raw.
  • While Sears is transforming itself into a faux Costco and Sam's Club via a "member-centric model", Target and Wal-Mart are aggressively expanding not only in the U.S. with a combination of large and small store formats, but right into a once dominant market for Sears in Canada. Moreover, an anchor store competitor in Macy's has invested robustly in inventory localization technology to meet consumer demands seemingly every trip to the store. How do I know Sears is failing to keep pace? You can observe the inventory bulges in certain classifications on the sales floor, and Land's End shorts on the tables along the East Coast stores in the middle of winter.

(Read more: Customers paying the price after Target breach)

Ready for the facts? Here you go …

9 must-know Sears & Kmart stats to share on social media

1. 29 percent: The percentage of the third-quarter 2013 sales drop that came from same-store sales, or stores open for longer than a year. Message: further market-share loss (can also infer this in the 10-Q comments explaining the sales declines at the divisions, as detailed below) despite traditional promotional efforts and the new "Shop Your Way" rewards program. With the loss in market share, the value of the top brands at Sears (for example Craftsman and Land's End) underlying the company's credit facilities and outstanding debt erodes, potentially impacting future borrowing ability and raising the cost of credit. I think this is a particular trend to watch in front of: (1) Sears' domestic credit facility maturity in April 2016; (2) Sears Canada credit facility maturity in September 2015.

2. 70 percent: the percentage of sales in the third quarter of 2013 devoted to "Shop Your Way", up from 65 percent in the year-earlier period. I reiterate this program is establishing a new low for the company's gross profit margin structure, a low that has yet to be fully realized. As this program rose as a percentage of sales in the third quarter, Kmart's gross profit margin fell 160 basis points due to sales declines in "most categories." Excluding one-time items, the Sears division's gross profit margin declined 60 basis points in the quarter, owing to weak sales in home appliances and apparel. In fact, while we are at it, let's track some 10-Q comments by Sears regarding its once bread and butter divisions in consumer electronics, tools, and appliances:

i. Q1 2013: Noted sales "declines in the consumer electronics and tools categories."

ii.Q2 2013: Noted sales "decrease in the home appliance category."

iii. Q3 2013: Noted sales "decreases in most categories including the consumer electronics, lawn and garden, tools, home appliances and apparel categories, as well as declines at Sears Auto Centers."

3. $208 million/$585 million: respective 39-week operating losses from Kmart and Sears.

4. -160/-80/-200 basis points: respective 39-week gross margin declines for Kmart, Sears Domestic, and Sears Canada.

5. -50.87 percent: 39-week decline in capex for Sears Canada. Total capex as a percentage of segment sales of 1.03 percent versus 1.09 percent a year earlier.

6. -53 percent: 39-week decline in capex for Kmart. Total capex as a percentage of segment sales of 0.4 percent (yes for real) versus 0.9 percent a year earlier.

7. 1.28 percent: 39-week ratio of capex to sales for Sears Domestic versus 0.7 percent a year earlier. By comparison on a 39-week basis: (1) Macy's 2.08 percent; (2) Wal-Mart 2.76 percent; Target 5.6 percent (inflated by company's entry into Canada).

8. 9: number of quarters for negative same-store sales from Kmart.

9. 1: number of positive same-store sales quarters for Sears Domestic out of the past eight quarters.

(Read more: Why Best Buy may be a bad buy: strategists)

A chilling chart: Sears debt yield

Amid Sears' worse-than-expected financials in 2013, and in spite of ample access to liquidity, yields on the company's debt have crept higher. Draw your own conclusions from the one-year chart below.

Two vines on Sears

Poor inventory planning systems/process underinvestment = seasonal excess. Overarching theme from our post-holiday store walks at both divisions: significant excess seasonal inventory that raises risk to the gross profit margins reported by the company.

Click here to watch the vine video.

Craftsman, hands down is a household brand. However, another thing we have seen at Sears consistently since the early stages of 2013: basic Craftsman hardware out of stock. When you are missing the basics that tradesman and the do-it-yourself consumer know your for, during a recovery in the U.S. housing market no less, that leads to a shift in sales to Home Depot and Lowe's, where people will find a greater selection of private label, high quality products. Not helping Sears' cause: Home Depot and Lowe's have invested aggressively in their online and delivery capabilities to the Pro customer base.

Click here to watch the vine video.

Slideshow: The byproduct of underinvestment

What has a dramatic reduction in inventory by Sears to extract cash caused? Missing sizes, and bare shelves in the traffic-driving basics. Be aware that Walmart stores experienced a resurgence in basic apparel sales in 2013, and my opinion is that actions at Sears and Kmart played a role in that. Note these are not one-off post-holiday type photos, they are part of a theme found in a long-running collection we have been keeping on the company from being in the field, and from contacts, for an extended period.

Look at these photos of the shoe department: The boxes are hanging out over the shelves, and the shelf itself is not equipped to stack enough inventory. In another thing we have long seen at Sears, the shelving has not kept pace with product innovation from key vendors.

And "end caps," as they're known, are prime real estate for retailers, but once again per the usual at Sears, the end caps are frequently out of stock. So much for capturing that passerby traffic, including from children that like to touch the merchandise and pull mom to the shelf.

Understocked shelves in the shoe department at a store. R: Empty “end cap,” which is usually an important component at stores.
Source: Belus Capital Advisors
Understocked shelves in the shoe department at a store. R: Empty “end cap,” which is usually an important component at stores.

Anchor department stores have been focusing more and more on improving their cosmetics experiences, especially Macy's and Target. This is below is the norm rather than the exception at Sears.

Cosmetics are increasingly important at many retailers – yet the shelves are empty at this store.
Source: Belus Capital Advisors
Cosmetics are increasingly important at many retailers – yet the shelves are empty at this store.

Basics end cap out of stock — that's a no-no in retailing. And, you'd think that an accessories display such as the one on the right should be stocked at Sears, doing so has the potential to train a new generation of consumers that Sears is kinda cool. No dice.

Even this clothing “end cap” is empty (L). Accessories have the power to say “hey, we’re kinda cool!” Not here (R).
Source: Belus Capital Advisors
Even this clothing “end cap” is empty (L). Accessories have the power to say “hey, we’re kinda cool!” Not here (R).

Sometimes it's hard to even tell what's being sold when there is a floating empty display. And forget, if you will, the substandard appearance of physical shelves — pay attention that basics like towels, which can be traffic drivers, are out of stock.

Wait, what is even sold here? The whole display is empty (L). Even basics like towels – which can be traffic drivers – are out of stock (R).
Source: Belus Capital Advisors
Wait, what is even sold here? The whole display is empty (L). Even basics like towels – which can be traffic drivers – are out of stock (R).

Excess in slow-moving inventory

Sears is consistently overstocked with merchandise in categories I would deem slow-moving, for instance fitness equipment. Note that a winning big box retailer, Dick's Sporting Goods, is devoting less space to fitness equipment nowadays. Message: The internals of the company are hollow due to frequent management turnover, bringing with it improper order forecasting.

Think you are fit enough to hurdle those machines below so as to browse?


Are you fit enough to hurdle these machines to browse the fitness aisle?
Source: Belus Capital Advisors
Are you fit enough to hurdle these machines to browse the fitness aisle?

Spotted: capex underinvestment

Want one glaring example of Sears Holding Corporation's underinvestment, here you go. In addition to this IBM computer setup being at three unmanned stations at the back of a Sears store (another theme for another day: excess capacity inside of stores built for traffic and sales levels from yesteryear), it's simply outdated compared to new technology on display at competitors. My view: slower checkout times during peak periods for consumers and the potential for errors as Sears invests in newer systems for its online platform.

Sears' response

Sears responded with this message on Twitter, saying: "@BrianSozzi: Can you pls share the exact store locations with us? Want to ensure we attend to these issues & meet our members's needs. Thx."

A great example of underinvestment at Sears – an IBM computer. Oh, and it’s unmanned.
Source: Belus Capital Advisors
A great example of underinvestment at Sears – an IBM computer. Oh, and it’s unmanned.

— By Brian Sozzi

Brian Sozzi is CEO and chief equities strategist of Belus Capital Advisors. Follow him on Twitter @BrianSozzi.

Disclosure: Neither Brian Sozzi nor Belus Capital Advisors own shares of any of the stocks mentioned here. Belus currently has "sell" recommendations for clients on Sears, Wal-Mart, and Target.

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