By Susan Chandler
Tribune staff reporter
Published September 29, 2002
Business could be better at Sears, Roebuck and Co.
Sales have declined every single month this year. During August, when parents rush to outfit their children for school, Sears' same-store sales plunged 11 percent, a double-digit decline that shocked even retail veterans.
But Sears Chief Executive Alan Lacy is still vowing to deliver a spectacular 22 percent increase in 2002 earnings per share, excluding one-time items. Sears reaffirmed that guidance Sept. 5, counting on cost-cutting and its lucrative credit-card business to save the day.
Now, some Sears watchers are raising doubts the company can deliver on its financial promises.
"They're dreaming," says George Whalin, president of Retail Management Consultants in San Marcos, Calif. "They're going to start reporting some really bad numbers."
On Thursday, Fitch Ratings lowered its outlook on Sears to negative from stable, citing weak sales trends, a difficult retail environment and growing competition from discounters and home-improvement chains. Although it applauded Sears' credit-card growth, Fitch also cited concerns about the quality of its portfolio if economic weakness continues.
Indeed, there is cause for concern, retail experts say.
While Sears' apparel sales have been weak for several years, the Hoffman Estates-based chain has been depending on its credit-card business and sales of big-ticket items like home appliances and consumer electronics.
But appliance sales, where Sears has a commanding 37 percent market share, weakened this summer despite aggressive promotions, including zero-percent financing offers.
Not only is that dragging down the company's top line, it eventually will crimp Sears' high-margin credit card business as well. Fewer big-ticket transactions translates into a smaller portfolio of credit card debt, retail experts point out.
The stakes are high as Lacy approaches his second anniversary at the helm of the nation's third-largest retailer, and his regime's credibility is on the line.
Paul Liska, Sears' new chief financial officer and a Lacy recruit, says he has a firm grip on reality and that Sears will come through with the upbeat numbers it has promised.
Despite sagging sales, Sears has been able to boost its efficiency by downsizing its headquarters staff in Hoffman Estates and de-layering its sprawling field organization, Liska says. Because the layoffs in Hoffman Estates--about 1,300 positions out of 7,000--mostly were over by the end of the first quarter, the company has been able to reap cost savings for almost the entire year.
"We're unique because our profitability is coming from productivity improvements," Liska said. "That's the beauty of productivity. It's totally within your control."
Declining sales expected
All along, Sears has said its 2002 sales would likely decrease. The steeper-than-expected August decline has to be averaged with smaller-than-expected sales declines in the first half, Liska says. "All of this was anticipated."
Overall, Sears is sticking with its prediction that annual sales will be down by about 5 percent, he says.
Sears isn't counting on a fourth-quarter miracle for that to happen. "If it is the same type of selling season as last year, and last year did not feel great, we're fine. We didn't expect the economy to get a lot better."
Anyone who suspects Sears might be too aggressive is off base, Liska adds. "We're a very conservative company on an accounting basis. We do everything according to Hoyle."
Wall Street doesn't seem overly concerned. Of the seven analysts reporting recommendations to Thomson Financial/First Call, none has changed their outlook on Sears' stock this month.
One analyst has Sears rated a "strong buy," and three analysts are recommending Sears as a "buy," according to Tom O'Keefe, equity research analyst with Thomson Financial. Three others have a "hold" rating on the retailer.
Only Merrill Lynch analyst Daniel Barry reacted after the September sales report, slightly trimming his third-quarter and full-year estimates for Sears' stock. And Barry is still expecting Sears to earn $5.31 per share, even more than the 22 percent increase Sears has promised.
But investors, chastened by accounting problems at other companies, don't appear quite as convinced.
Sears' stock price has drifted down from a high of almost $60 a share this summer to about $41, losing almost a third of its value and outpacing the overall market's decline of about 20 percent. Even so, Sears' stock remains well above its 52-week low of $31 per share.
Cash flow questioned
Although mainstream analysts appear comfortable with Sears' earnings story, a small investment firm in Sarasota, Fla., is sounding an alarm.
StockDiagnostics.com Inc. has a proprietary software system that looks for contradictory indicators in a company's financial reports. And Michael Markowski, the firm's director of research, believes it has found some at Sears.
In the second quarter, when Sears was posting record net income, it also was recording negative cash flow on an operating basis, which means it was paying out more money than it was collecting.
That's a financial anomaly that should be raising red flags for investors, Markowski says.
"They're telling you they're making a lot of money, but they're not generating any cash," he said. "The problem is that, generally, companies generating negative operating cash flow are trying to do whatever they can to maintain Wall Street's projections. They're stretching."
Sears' cash flow has been negative for the past two quarters because of a big increase in receivables, which is money that Sears is owed by shoppers on its credit cards, Securities and Exchange Commission filings show.
Stricter credit controls
While more credit card debt means more interest and fees for Sears, it also sets the stage for trouble if customers can't make their payments. That's exactly what happened to Sears in the mid-1990s when a big push to get more credit cards in the hands of consumers created a flood of bad debt that dragged down earnings several years later.
Since then, Sears has cleaned up its portfolio and tightened collection policies. But there's no doubt that Sears is hitting the accelerator on its credit business again. Since Sears introduced a Sears Gold MasterCard in June 2000, shoppers have racked up an impressive $8.50 billion in balances, a good portion of that outside Sears' stores.
At the end of June, Sears had $29.81 billion in credit card debt outstanding, up 8 percent from a year earlier, most of it on the traditional Sears in-store card.
Liska denies that Sears is stretching. He says the negative operating cash flows are simply a sign that Sears is growing its credit business, which is a "good thing" because "that's how we make a lot of money."
StockDiagnostics.com's analysis is flawed, Liska says, because the software program doesn't work with financial companies, and Sears, which earns more than 60 percent of its profit from credit cards, is a finance company.
"If these models really worked, this guy would operate a hedge fund. He wouldn't be running a Web site," Liska said.
Markowski says it's news to him that Sears is a finance company rather than a retailer. And he says he will really be concerned if Sears posts a third consecutive quarter of negative cash flow.
Sears' third-quarter earnings are due in mid-October.