Outlet stores

Sears Holdings bankruptcy could drag Sears hometown and outlet stores down

Six years ago, Sears Fund (NASDAQ: SHLDQ) separated from its mostly franchised small town stores and outlet stores into a separate publicly traded company: Sears Hometown and Outlet Stores (NASDAQ: SHOS).

The spin-off’s shares debuted at around $ 30 and prospered briefly, but almost all of them have been down in the past five years. A combination of price pressure in Sears Hometown’s main home appliance market and general retail unrest has resulted in a long series of losses. For most of 2018, shares of Sears Hometown and Outlet Stores traded at around $ 2.

Stock performance of Sears Hometown and Outlet Stores, as reported by YCharts.

The results finally started to improve in 2018, raising the hopes of some shareholders of Sears Hometown. However, Sears Holdings’ recent bankruptcy filing represents yet another blow from which Sears Hometown and Outlet Stores may not be able to recover.

The case of Sears Hometown and Outlet stores

Bulls often point out that Sears Hometown and Outlet Stores shares trade at a significant discount to book value. The company’s market capitalization hovered around $ 50 million recently, while its book value was $ 155 million in early August. In theory, shareholders could make big profits if the company simply ended operations in an orderly fashion and converted its inventory and other assets to cash.

That said, the book value was over $ 400 million at the start of 2015. The big losses between 2015 and 2017 destroyed most of that value. This highlights the importance of getting back to profitability as soon as possible.

Fortunately, Sears Hometown and Outlet Stores seem to be on the right track. It adjusted its pricing strategy and renegotiated certain supply contracts to increase its gross margin. The company has also made an effort to cultivate an identity that is independent of its former parent company, including a nationwide advertising campaign highlighting local ownership of most of its stores.

These efforts appear to be gaining ground. In the first half of fiscal 2018, Sears Hometown and Outlet Stores’ adjusted EBITDA jumped to $ 14 million from a loss of $ 6 million a year earlier, while its net loss narrowed to $ 19 million. of dollars against 51 million dollars. Yet the bankruptcy of Sears could quickly stifle this momentum for two main reasons.

The exterior of a full line Sears store

Sears no longer owns the Sears Hometown chain, but do customers know? Image source: Sears Holdings.

The company is still very dependent on Sears

The first reason is that there are still many links between the two companies. On the bright side, Sears Hometown is near the end of a multi-year process of developing its own IT capabilities.

On the flip side, while the company has struggled to sign direct sourcing agreements with suppliers, it still bought 78% of its merchandise from Sears Holdings last year (up from 80% over the past year). of the 2016 financial year). This likely reflects the importance of Kenmore appliances and Craftsman tools in the Sears Hometown merchandise mix. In fact, the household appliances and tools categories represented 77% of sales in the first half of fiscal 2018.

For now, Sears Holdings is operating normally despite filing for bankruptcy. That said, liquidation is a possible outcome – and could occur as early as the first half of 2019. That would force Sears Hometown to scramble to find new suppliers. He would also lose the purchasing power of Sears Holdings, which currently supplies him with merchandise at cost. As a result, Sears Hometown may have to pay more for the merchandise, reducing its profitability.

Even if Sears Holdings remains in business, its financial situation is expected to remain precarious. He tried to save money by cutting his marketing budget to the bone. This means less exposure for the Kenmore and Craftsman brands, which has weighed on sales at Sears Hometown and Outlet stores over the past year.

Do customers understand the difference?

The intangibles of the Sears Holdings bankruptcy could have an impact just as big on Sears Hometown as the more practical issues. The bankruptcy filing was national news, due to the company’s history as one of the pioneers of retailing in the United States. The distinction between Sears Holdings and Sears Hometown and Outlet Stores is a much more subtle point – one that even the mainstream media has sometimes overlooked.

As a result, customers may not realize that the bankruptcy of Sears Holdings does not have a direct impact on Sears Hometown or Sears Outlet stores. It might make them nervous about shopping there.

Of course, Sears Hometown and Outlet Stores will likely continue to promote its independence from Sears Holdings – and the predominantly franchise nature of the Hometown chain. But he might be forced to dramatically increase his marketing spend just to avoid losing customers. It’s an expense she can’t really afford, as the business still hasn’t broken even.

Secular trends are not favorable either

In addition to the headwind created by the Sears bankruptcy, the Sears Hometown chain is likely to face competitive pressure from the growth of e-commerce. Historically, the chain’s competitive advantage has been that many of its stores are the only game in town.

Electronic commerce has given consumers more options. While home appliance sales have not grown as fast as other categories of merchandise online, it’s safe to assume that people will become more comfortable buying home appliances online over time. This means that Sears Hometown could face stiff competition from large retailers with a much larger scale of purchase.

The Sears Outlet segment is more promising due to its dominant position in the “as is” household appliance clearance industry. However, it represents less than a third of the company’s total turnover. Between the short-term headwinds of the Sears Holdings bankruptcy and the uncertain future of the Sears Hometown business, investors should likely avoid Sears Hometown and Outlet Stores stocks – even if they are trading for a fraction of book value .

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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