Bondholders Fret as Sears Burns Cash

The company buys back stock while its credit rating falls

Bondholders and ratings agencies are taking an increasingly dim view of Eddie Lampert’s Sears Holdings, owner of the Sears and Kmart chains. Even though it lost $170 million in the first quarter, the company last month said it would spend as much as $500 million to buy back shares. On June 21, Fitch Ratings cut Sears’s rating to B, five levels below investment grade, citing a “precipitous decline” in earnings.

TD Asset Management’s Greg Kocik says the company’s priorities are wrong. “It’s not the right time to buy stock,” says Kocik, lead manager of the TD High Yield Bond Fund, which owns Sears debt. “They just need to hunker down and refocus on better execution.” Sears sold $1.25 billion of secured bonds yielding 6.625 percent in September, in part to fund stock repurchases. The price of those bonds, due in October 2018, fell to 90.3¢ on the dollar on June 16 from 92.5¢ at the end of May as investors fretted about declining earnings. Sears has about $3.5 billion of debt, according to Monica Aggarwal, an analyst who grades the company at Fitch.

Lampert, the billionaire manager of hedge fund ESL Investments and Sears’s chairman, has a history of favoring shareholders by buying stock instead of cutting debt, Kocik says. “Our behavior and focus has served our shareholders well over the past eight years,” Lampert said in a letter to investors on Feb. 24. Kimberly Freely, a Sears spokeswoman, declined to comment.

Sears’s stockpile of cash and cash equivalents fell to $952 million as of Apr. 30, down from $1.74 billion a year earlier. The retailer may generate “well under” $1 billion of earnings before interest, taxes, depreciation, and amortization this year, down from $1.3 billion last year, according to Aggarwal. That’s less than the $1.5 billion Sears needs to cover expenses, says Aggarwal: “We think that free cash flow will be negative this year.”

In February, Lampert installed Lou D’Ambrosio, who spent 16 years at IBM, as chief executive officer. D’Ambrosio is Sears’s fourth CEO since 2005, when Lampert’s Kmart Holding bought the company for about $12 billion and took the Sears name. In May, Sears appointed William Phelan as acting chief financial officer. He’s the fifth person to hold that position since the acquisition. Lampert has made several efforts to revamp Sears stores, to little effect. Now he is counting on an online expansion to reverse declining sales, as Sears loses customers to discounters such as Wal-Mart and Target as well as specialty stores that sell only clothing or appliances. The company’s revenue has fallen every year since 2007. Sales at Sears stores in the U.S. open at least a year fell 5.2 percent in the first quarter and 1.6 percent at the Kmart chain, which generates about a third of the company’s revenue. Same-store sales at J.C. Penney rose 3.8 percent in its most recent quarter.

Sears laid off 700 appliance salespeople at Kmart on June 13. The retailer spent $441 million on property, buildings, and equipment last year, about 1 percent of revenue. That’s less than the 3 percent average for similar retailers, according to Aggarwal. “There’s only so much you can cut costs,” she says. “They’ve already underinvested in the business for years.”


    The bottom line: Bondholders would like to see Sears retire debt and improve operations rather than buy back $500 million in stock.

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