Sears Holdings (SHLD) continues to close stores at a torrid pace, with another 43 stores set to be closed within a few months. This brings the total store closures during 2017 to over 300. Kmart is affected more by the store closure announcements than the Sears banner, as has been typical in recent years.

Sears's partnership with Amazon (NASDAQ:AMZN) should help preserve some value for its Kenmore brand and Sears Home Services as it continues to close stores. The decision to sell Kenmore outside of Sears will likely accelerate Sears's comparable store sales decline though, and contribute to further store closures. Faster store closures are favorable to shareholders, who have seen Sears's retail operations swallow up much of its asset value. However, I think the more bullish estimates of its real estate value are quite overstated, leaving no margin of safety for its equity in the end.

Kenmore And Amazon

Sears's deal with Amazon to sell Kenmore appliances is generally a positive for the company. Kenmore sales have been declining for years as Sears stores close and have consistently negative same store sales. Kenmore's share of major appliance sales has fallen dramatically according to Stevenson TraQline, with its market share going from 16.7% in the 12 months ending March 2013 to 10.3% in the 12 months ending March 2017. This partnership helps preserve some of Kenmore's value, which was evaporating as Sears closed stores and lost customers. Now even as Sears's retail sales crumble, there will still be a major distribution channel available for Kenmore. Sears Home Services should also benefit, as now there likely will be more Kenmore owners than there otherwise would have been.

Amazon is currently not a huge player in major appliances with only a 1% market share. Most of Amazon's major appliance sales appear to come via its Marketplace as it only carries a limited number of major appliance products directly. However, online major appliance sales are growing quickly and adding Kenmore to Amazon should result in a noticeable boost in Amazon's market share, even though Kenmore customers tend to skew different demographically compared to Amazon customers.

While this partnership is a boost for Kenmore and Sears Home Services, it will likely serve to also accelerate the decline of Sears retail some more. For example, if Amazon triples its market share of major appliances and around 50% of that increase is cannibalised from Sears stores, it would knock another couple percent from Sears's comps (and around 3% to 4% off Sears Domestic comps). That does not include any additional lost sales from associated foot traffic decline if Kenmore shoppers make fewer visits to Sears stores.

In terms of profitability, the effect is likely to be limited for now. Sears will have lower margins on Kenmore sales since it loses the retailer markup. This gives Sears even more incentive to continue closing stores and eliminate the costs associated with those stores.

Effect Of Store Closures

After the most recent store closure announcement, it appears that there will be no more than 523 Kmarts still in business at the end of Q3 2017. This is a 35% reduction from the 801 Kmarts that were operating at the end of Q3 2016. There haven't been as many Sears store closures, but it appears that there may still be a 15% reduction in full-line Sears stores from Q3 2016 to Q3 2017.

The store closures should allow Sears to significantly reduce inventory levels, which will benefit its cash flow. Sears Holdings had $3.48 billion in net inventory (inventory less merchandise payables) at the end of Q3 2016, so the store closures could potentially contribute around $650 million to cash flow even with merchandise payables increasing as a percentage of total inventory. There are store closing costs to deal with, but Sears may still end up benefiting by around $400 million net of those costs.

Surviving Another Year

Sears appears to be on track to survive until at least 2018. It has apparently closed on around $400 million in real estate transactions so far in 2017 and also sold Craftsman for $525 million up front, plus additional payments, including $83 million that can count towards its pension funding obligations for 2017. Combined with the estimated $400 million net benefit from closing stores, these various items add up to around $1.4 billion so far.

That $1.4 billion plus the potential proceeds from other real estate transactions and the additional funding that Sears has lined up should likely be enough to see Sears through to 2018.

Kmart Leases

Although Sears is touted as having a large real estate portfolio, it should be noted that a significant portion of its real estate square footage (estimated at close to 40% at the end of 2016) consists of leased Kmart locations.

While some Sears leases (primarily those attached to top malls) may be quite valuable, most Kmart locations are standalone locations or part of local strip malls. As shown by Target (NYSE:TGT) Canada's bankruptcy sale, these locations probably have minimal net value unless there is some catalyst (such as Target's initial entry into Canada) that results in demand for a massive number of locations at one time, and that cannot be supplied by other methods. With department stores and other retailers closing many physical locations in the United States, it seems unlikely that anyone would pay a significant premium for leases that aren't located in top malls.

Target Canada's bankruptcy filing resulted in the sale of its leases (described as with below-market rents), which fetched drastically less than what Target paid for those leases in the first place. A handful of the leases (those located in top malls) fetched a significant amount of money, with 11 leases going for $138 million CAD ($110 million USD) to the mall landlords. The remaining 126 leases appear to have netted around negative $23 million CAD (negative $18 million USD) after approximately $180 million CAD ($144 million USD) in landlord claims were factored out.

This indicates that the Kmart leases potentially have negative combined value (net of lease termination costs) outside of the Manhattan locations. There is less retail space per capita in Canada as well, so assuming that the non-Manhattan Kmart leases have the same average value as the non-top mall Target Canada leases is probably generous to Sears.

The two Vornado Manhattan Kmarts apparently have lease options until 2036 and Vornado has had discussions with Sears about those properties for years, but have been unable to reach a deal. Theoretically the leases for those properties could be worth $100+ million each, but it is uncertain how negotiations would shake out.

Overall, the Kmart leases (representing close to 40% of its real estate square footage) are probably worth less than $200 million combined net of lease termination costs.

Conclusion

Sears's partnership with Amazon will help some elements of the company retain value as its retail sales continue to implode. It also appears likely to survive another year via asset sales, inventory reductions and debt funding. However, I still believe that its equity is likely to end up with minimal to no value in the end. Sears's retail operations are continuing to gobble up its cash, resulting in Sears needing to arrange funding at very expensive rates (9.75% for a short-term secured line of credit). The margin of safety provided by its real estate also appears overstated, with a significant portion (such as its Kmart leases) having minimal value.

With Sears's equity likely to have minimal to no value in the long run, and Sears also likely surviving another year, there doesn't appear to be a great way to play the stock for the long-term. The cost to short is too high to effectively hold a short position for a whole year. Sears may make a good shorter-term trading stock however.

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https://seekingalpha.com/article/4089784-accelerating-death-sears-retail