JULY 24, 2003
STREET WISE
By Robert Berner
The Struggle in Store for Sears | Selling the credit-card division has lifted the stock and bought time for tackling the retailer's biggest woe: Sales that keep on shrinking
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With the July 15 sale of Sears Roebuck's credit-card business to Citigroup (C ) for $3 billion, CEO Alan Lacy bought the struggling retailer some much-needed time and wowed Wall Street, which hadn't expected the operation to fetch anywhere near that price. Now, as Lacy focuses on turning around the outfit's ailing retail unit, the extent of investors' patience remains to be seen.
Just two days after the deal was struck, the news out of the venerable retailer's Hoffman Estates (Ill.) headquarters was sobering: Sears (S ) was reporting a 31% decline in second-quarter profits (excluding one-time gains) and lowering guidance for the year. That announcement underscored the hurdles Lacy must overcome, since falling profits at Sears' retail operations were to blame for the decline. "I don't see signs" of a turnaround, says Dreyfus retail analyst Elaine Rees.
Investors are giving Lacy the benefit of the doubt, at least for now. And the Street clearly found much to cheer in the price Lacy received for the credit business, which has struggled with rising charge-offs since last fall. Since the announcement of the Citigroup deal, expected to close by yearend, Sears' stock has risen by 14%, closing at $40 on July 23.
SWEET PLUSES. The $3 billion Citigroup is paying for the credit unit, equal to a little more than 10% of the $29 billion in receivables, nearly double analysts' expectations. In addition, disposing the division will free another $3 billion that Sears had dedicated as a reserve on its balance sheet to cover losses on bad credit-card debt. All told, the sale creates $6 billion in pretax proceeds, or $4.5 billion aftertax.
Making the deal sweeter, Sears estimates it will receive $200 million annually from Citigroup in performance payments for opening new accounts and generating sales paid for with those in-house credit cards. Nor will Citigroup charge Sears for short-term, 0% finance offers. That will save Sears' retail operation approximately $200 million annually, since the credit division now charges the retail unit for those consumer promotions and incentives. Combined, the performance payments and finance savings will net retail operations at least $260 million annually after taxes, predicts Joseph Grabowski, an analyst at Strong Capital Management.
That certainly gives Lacy some room to maneuver, Grabowski adds, even if retail profits continue to be sluggish in 2004. He sees Sears' store business posting net income in 2003 of $630 million, which would be flat with 2002. But even if next year's retail profits don't rise, the performance payments and finance savings would boost Sears' net closer to $900 million. Meanwhile, analysts say it's almost certain that Sears will use the bulk of the $4.5 billion proceeds from the sale to buy back stock.
RECOVERY POSTPONED. Sears spent a mammoth $1 billion on its own shares in the second quarter -- acquiring 11% of those outstanding -- and its board has just authorized another $1 billion buyback. Reducing the number of outstanding shares will put additional lift under the stock and is likely to accelerate earnings-per-share (EPS) growth. Says Grabowski: "I could see Sears' stock trading at $50 in the first couple months of [2004]."
Other analysts are more dubious, questioning why investors would want to reward earnings growth that doesn't stem from increased sales. For each of the past 22 months, same-store sales (those at locations open for at least a year) have declined -- and they have done so despite all efforts to stop the bleeding, such as Sears' acquisition in 2003 of apparel catalog outfit Lands' End. Plus, the retailer has continued pushing back its forecast for when same-store sales will turn positive, with the latest estimate being before yearend.
Further highlighting the importance of reviving sales growth: The performance payments and finance savings will provide a once-only boost to annual earnings, and they'll be built into all comparisons made in subsequent years. In the past, Sears could often count on credit income as a hedge against weak retail profits, as was the case in 2000 and 2001. With that option gone, investors "will be forced to pay more attention to the retail operations," notes Gimme Credit analyst Carol Levenson in a report.
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Copyright 2003, by The McGraw-Hill Companies Inc. All rights reserved.
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