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Sears Holdings Corporation (SHLD), Macy’s, Inc. (M), Kohl’s Corporation (KSS): This Retailer Might Be The Worst Investment You Can Make Right Now

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The business of retailing is quite simple. You have a large base of fixed costs tied up in real estate, inventory and personnel, and you aim for a base of sales above those expenses. When that happens, each incremental new dollar of sales can quickly flow to the bottom line.

But this kind of operating leverage can work the other way, as falling sales make it harder to cover costs. That’s the kind of negative leverage that has been in place for some time at Sears Holdings Corporation (NASDAQ:SHLD), which just announced another dismal quarter at both its flagship Sears stores as well as its Kmart stores. If the current sales trends continue, Sears Holdings Corporation (NASDAQ:SHLD) won’t even be around in five to 10 years.

I highlighted this retailer’s woes in late May and though shares are down more than 15% since then, much more downside lies ahead.
Sears Holdings CorporationAs I noted in that piece, Sears Holdings Corporation (NASDAQ:SHLD) has generated a cumulative $1.7 billion in negative free cash flow, offset only by the fact that Sears Holdings Corporation (NASDAQ:SHLD) has been selling off key assets to keep the balance sheet from sinking.

Well, Sears’ second-quarter results paint a picture of even deeper distress. Same-store sales were negative at Sears, Kmart and Sears Canada. Coupled with the closing of several stores, Sears Holdings Corporation (NASDAQ:SHLD) saw sales drop 6.3% from the same quarter last year. Sears’ quarterly sales base of $8.9 billion lagged behind analysts’ consensus forecasts by a stunning $600 million. Who knows how bad the sales trends would have looked had Sears not resorted to a heavy slate of promotions.

A sure sign of retail distress: Sears’ gross margins fell to just 24.6% as the company slashed prices to lure customers. To put that in perspective, other retailers such as Macy’s, Inc. (NYSE:M)Kohl’s Corporation (NYSE:KSS) and The Home Depot, Inc. (NYSE:HD) have gross margins that are 10 to 15 percentage points higher.

This retailer is rarely profitable outside the holiday-focused fourth quarter, but a current quarterly loss of $194 million is far worse than last year’s $132 million quarterly loss, and roughly $40 million worse than analysts had been expecting. Were it not for some one-time gains on asset sales, Sears Holdings Corporation (NASDAQ:SHLD)’ operating loss would have swelled to $235 million.

To stem the hemorrhaging, CEO Eddie Lampert is trying to turn the retailer into a membership club. That strategy has worked wonders for companies like Costco Wholesale Corporation (NASDAQ:COST) and BJ’s Warehouse, but Lampert is kidding himself if he thinks he can succeed in this already mature category.

The eponymous Sears stores are already showing signs of trouble as same-store sales remain negative, but the Kmart stores, which were acquired for $11 billion in cash and stock back in 2004, are an absolute disaster. Store traffic has become so weak that another round of store closures is almost inevitable from the current base of 1,261 stores. And that will yield negative economies of scale in terms of merchandising and advertising. At some point in the next few years, Sears may need to simply shutter the entire Kmart division.

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