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Sears Holdings Corporation (SHLD), J.C. Penney Company Inc. (JCP): The Bad News

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Last week, storied retailer Sears Holdings Corporation (NASDAQ:SHLD) whiffed on earnings for the second straight quarter . The company posted an adjusted loss of $1.46 per share, while adjusted EBITDA swung from a gain of $116 million in the second quarter of 2012 to a $55 million loss.

Sears Holdings Corporation (NASDAQ:SHLD) has experienced declining domestic comparable-store sales for more than a decade, as the Sears and Kmart chains have failed to keep pace with the rest of the retail industry. Given this consistently poor performance, it’s impressive that the company is still in business. Sears has survived primarily because of a long string of asset sales that have brought in a steady stream of cash.

Sears Holdings CorporationStill, this trend is clearly unsustainable. Eventually, Sears Holdings Corporation (NASDAQ:SHLD) will run out of assets to sell, and will need to generate cash flow from its operations in order to stay solvent. The odds are stacked against Sears, yet there are some reasons for hope. Unlike fellow department store operator J.C. Penney Company, Inc. (NYSE:JCP— which seems to be entering a death spiral — some important aspects of Sears’ business have stabilized. Moreover, the company’s strong liquidity position gives management plenty of time to continue transforming the business.

The bad news
Domestic comparable-store sales declined by 1.5%, with Kmart performing worse than Sears Holdings Corporation (NASDAQ:SHLD)’ namesake department stores. Sears’ performance was weighed down by poor sales in the appliance department, typically one of the company’s strengths. Meanwhile, Kmart’s sales were weak across a number of “transactional” categories such as grocery and pharmacy.

Some of Sears Holdings Corporation (NASDAQ:SHLD)’ troubles can be explained by macroeconomic factors. Many major retailers have reported worse-than-expected results recently. That said, unlike Sears, The Home Depot, Inc. (NYSE:HDsaw a strong increase in appliance sales last quarter. If Home Depot is taking lots of appliance and home improvement business away from Sears, it bodes ill for Sears’ long-term health.

The bright spots
Not everything about Sears Holdings Corporation (NASDAQ:SHLD)’ performance was disastrous, though. In fact, Sears showed marked improvement in a few key areas. First, Sears achieved a same-store sales increase in apparel — typically a high-margin category — for the eighth consecutive quarter. Second, online revenue grew by 20%. Both of these figures suggest that Sears is benefiting from J.C. Penney Company, Inc. (NYSE:JCP)’s ongoing struggles.

Lastly, Sears Holdings Corporation (NASDAQ:SHLD) saw a significant increase in the number of shoppers using its “Shop Your Way” rewards program, indicating higher customer engagement (although that also created margin headwinds). Sears executives believe that “Shop Your Way” members will become more loyal to Sears and Kmart, eventually leading to higher sales.

A plausible plan
While Sears Holdings Corporation (NASDAQ:SHLD) has been losing money for many years now, the company has a plausible plan for returning to profitability and generating positive cash flow. The company has been working to reduced its fixed cost base for several years, and is also trimming inventory in order to improve cash flow.

However, the biggest change to Sears Holdings Corporation (NASDAQ:SHLD)’ philosophy is a focus on personalization. Online retailers like Amazon.com, Inc. (NASDAQ:AMZNhave thrived by personalizing their websites to each customer. Visitors to Amazon’s website will see purchase suggestions based on their browsing history and past purchases. By contrast, mass retailers have continued to send the same weekly or monthly promotional flier to all customers.

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