A merger that never made sense
When I first heard that Kmart and Sears Holdings Corporation (NASDAQ:SHLD) would merge, my thought was, why? Years later, this merger still baffles me. The traditional Sears store is normally located in an enclosed mall, is well known for appliances, tools, and lawn care, and recently the company’s fashion selection has improved. The traditional Kmart store is normally free standing, and is best known by Dustin Hoffman’s line in Rain Man, “Kmart sucks.”
The merger of these two completely different companies was supposed to bring efficiency and better profits. In theory, Kmart could show Sears how to sell items at a discount, and Sears Holdings Corporation (NASDAQ:SHLD) could bring some of their higher-end retail knowledge to Kmart. However, what has actually happened is Kmart is constantly stuck playing third string to Target Corporation (NYSE:TGT) and Wal-Mart Stores, Inc. (NYSE:WMT). Sears, on the other hand, has been so distracted by Kmart and Sears Canada, that results have been less than impressive. The bottom line is, these two companies need to part ways.
What can Sears do?
Sears domestic division saw increased comparable store sales in apparel, home appliances and other home categories. The company’s weakest areas were consumer electronics, sporting goods, and lawn & garden. While Sears domestic unit reported same-store sales up 0.8%, there is room for significant improvement.
To be blunt, Sears Holdings Corporation (NASDAQ:SHLD) needs to take a page out of Kohl’s Corporation (NYSE:KSS) playbook. Kohl’s is centered around fashion choices, and Sears needs to take this step. Companies like Dicks Sporting Goods Inc (NYSE:DKS), Foot Locker, Inc. (NYSE:FL), and Amazon.com, Inc. (NASDAQ:AMZN) are killing Sears in the sporting goods area, and this part of the store needs to go. Electronics are also not Sears’ strong suit, and need to be eliminated also. Let’s face it, Amazon.com can sell it cheaper, Best Buy Co., Inc. (NYSE:BBY) has more selection, and Target Corporation (NYSE:TGT) and Walmart are more convenient.
If the company makes these choices, they will play to their strengths. Sears Holdings Corporation (NASDAQ:SHLD) is well known for appliance sales. The company’s Land’s End, and other clothing lines would have more store space by eliminating sporting goods and electronics. These changes would theoretically improve Sears’ gross margin, which is 27.1% domestically. The cut throat pricing in electronics and sporting goods is dragging the company down. Kohl’s Corporation (NYSE:KSS) is more fashion focused and carries a gross margin of 38.13%. You can see the type of margin improvement that might occur if Sears focused on clothing.
That darn third string
To say that Kmart needs to be cut loose is a nice way of saying, this dog needs to be put out of its misery. Kmart is clearly having trouble competing with Target Corporation (NYSE:TGT) and Walmart. Kmart’s gross margin last quarter was just 23.4% compared to 27.7% at Target and 24.85% at Walmart. With both Walmart and Target showing positive same-store sales, and Kmart showing same-store sales down 3.7%, shoppers are making the choice to walk away from Kmart every day.
One of the factors that Kmart said led to their declining sales was a, “significant decrease in consumer electronics.” This isn’t a surprise as even Best Buy is losing this battle. What was more condemning is, Kmart also said that they saw declines in grocery and household sales. Walmart and Target Corporation (NYSE:TGT) have both been expanding their grocery selections, and Walmart recently said it’s taking market share. The bottom line for Kmart is, sell it, spin it off, whatever it takes, Sears needs to let it sink or swim on its own.
Would you buy what’s left?
If Sears takes the steps to divide the company, and focus on the Sears Holdings Corporation (NASDAQ:SHLD) domestic business, the obvious question is, would investors buy? Given that Sears is currently expected to post losses each of the next two years, anything is better than where things currently stand.
Sears domestic business has positive same-store sales, and would have the opportunity to significantly increase their gross margin. Investors would need to treat this company as a turnaround play, and that is if the company would make these bold choices. In the meantime, investors have multiple choices of retailers that are doing better today. Kohl’s Corporation (NYSE:KSS) pays the highest yield at about 3%, and the company’s growth rate of 6.4% might be improved by being a bit more price competitive. Since Sears pays no yield and is expected to report negative growth, this is a no-brainer.
However, if investors are looking for the anti-Sears Holdings Corporation (NASDAQ:SHLD), look no further than Target Corporation (NYSE:TGT) or Walmart. Both of these companies are partially responsible for where Sears and Kmart are today. They both pay yields of over 2%, and are expected to grow by better than 8% to 11% in the next few years. Sears investors have two choices, either hold on and hope their company makes a wise decision to split, or stop throwing good money after bad. Given the alternatives available, I don’t see a great reason for investors to wait around.
The article Throwing Good Money After Bad originally appeared on Fool.com and is written by Chad Henage.
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