Top-Line Sales Growth Needed To Satisfy Shareholders - Sears, Roebuck and Co - Brief Article - Statistical Data Included

DSN Retailing Today, Dec 11, 2000

It's never a good sign when financial analysts resort to recommending a retailer's shares b cause they're cheap. It usually means the company in question has minimal top-line sales growth, and profits are being generated by other means. Nevertheless, such is the case with Sears.

Customers who pay for merchandise with their Sears credit card and then pay finance charges to Sears accounted for a disproportionate percentage of last year's profits, and will again this year. The company has 39 million credit card holders and a receivables portfolio of $27 billion. Operating income from credit operations generated $1.3 billion of Sears' $2.5 billion operating income last year, even though total credit revenue of slightly more than $4 billion represented only 10% of total company revenue of $41 billion.

With credit operations shoring up the bottom line, Sears' aggressive repurchase of its own shares also helps the profitability picture. Buying back stock reduces the number of outstanding shares and effectively boosts earnings per share calculations by spreading profits over a smaller base of shares. In March 1999, the Sears board authorized the expenditure of $1.5 billion for share repurchases, and it authorized another $1 billion this past August.

Without its highly profitable credit card operation and a massive share repurchase program, it is difficult to find other compelling reasons to own Sears. As Prudential analyst Wayne Hood noted earlier this year, "It has been easier for most analysts to write Sears off than attempt to understand how it could improve sales and earnings visibility."

This is partly because Sears isn't achieving profit growth in the straightforward manner to which retail analysts are accustomed. For starters, the company doesn't have many expansion opportunities for its flagship, full-line department stores. Its 860 full-line stores are already anchor tenants in all but the most upscale of malls, and the opening of new regional malls are few and far between. Last year, sales from full-line stores located in the United States totaled $23.7 billion, a 2.8% increase from the previous year. A similar increase is expected this year.

If Sears were able to grow the square footage of its store base, it would be easier for analysts to project where sales and profits are coming from. As it is, they are left to decipher the earnings impact of credit card charge-off rates and calculate earnings per share when one of the variables involved in the formula is a moving target.

Sears becomes an easier investment story to follow, and its sagging stock price would respond favorably if it could wring higher sales and profits from full-line stores.

This has to happen soon because analysts are growing skeptical of the credit operations.' ability to continue carrying the load.

"Strong gains in the credit business have driven [return on investment] for the past seven out of eight quarters," according to Dan Barry of Merrill Lynch. "Moderating credit gains going forward could begin to dampen ROT gains if apparel sales do not begin to accelerate."

Improving apparel sales and soft lines sales overall continues to be a key challenge for Sears. While the company is unquestionably a destination for big-ticket hard lines items such as appliances and power tools, it is not the first place most women think of for apparel or footwear purchases. With these categories, Sears finds itself stuck between more traditional discount retailers on one side and better department stores on the other. Women who can afford to are likely to head for the upscale anchor at the other end of the mall. Those who are on a budget have discovered in recent years that Wal-Mart and Target sell pretty nice clothes--and the prices are less expensive than Sears. It is a real trouble spot and negatively affects analysts' views of the company.

"Performance at retail in the third quarter continues to be driven by hard lines, where same store sale rose at a mid-single digit rate, while soft lines sales were flat--which was not dissimilar to previous months' trends," according to Rick Church of Salomon Smith Barney. "We do not foresee a meaningful change in these trends in the fourth quarter."

Next year is another matter, and Sears is one of America's best known brand names. The company has Alan Lacy in place as its new chairman, president and ceo, and everything is on the table. Initiatives are underway to improve global sourcing, strengthen private brands and do a better job of communicating the Sears value proposition to customers. There are also promising growth vehicles on the horizon. The Great Indoors test stores have performed well and former chairman, president and ceo Arthur Martinez has stated publicly that the home decor store format could eventually contribute $8 billion to $10 billion in revenue.

Analysts have also interpreted comments by Sears management to mean the retailer's National Tire & Battery stores and Sears Hardware stores might be divested, as those formats' ability to contribute to Sears' future growth is questionable.