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Perspectives May Obscure Sears' Real Needs

Perspective is an interesting thing, particularly when it comes to Sears Holding (SHLD), a retailer that is run by the man who runs the hedge fund that owns the retailer, Edward Lampert.

Perspectives can get a bit confused â€" or at least confusing to observers -- when an executive has a dual responsibility to the retail enterprise, including its other stockholders, and investors in the hedge fund that owns an appreciable share of the company.

Gregory Melich, a Morgan Stanley Research analyst, reviewing Sears Holding's recent quarterly numbers had some questions about how the money it generates is being distributed.

Sears had some positive things to talk about in the latest quarter, including a lower than expected loss and positive comparable store sales â€" those in stores open for more than a year â€" at the company's Kmart division.

Yet, Melich has some concerns. Among them liquidity in the lead up to next year's holiday season due to concerns about how much Sears will have available to build inventory under revolving credit agreements. In a research note, he pointed out that the "2010 revolver only has $2.4 billion of capacity" assured to the retailer.

He added, "In 2010, if Sears Holding free cash flow does not benefit from working capital as in 2009, building inventory in 2010 could be tight given current access to liquidity."

Not only that, but he pointed out that Sears, in an ongoing effort to boost its share price, bought back about $224 million in stock in the third quarter. He didn't mention paying down debt related to the acquisitions that resulted in today's Sears Holding, but the company has done that, too, to the tune of $678 million toward the $3.8 billion total.

Paying down debt and buying back stock can be a good thing. They make the balance sheet look better and the shares dearer. Yet, the question arises, should Sears Holding be fixing its balance sheet, its immediate share price or its stores? Lately, the company has been getting traction on some of its initiatives. Even though he has a sell rating on the chain, analyst Jason Asaeda of Standard & Poors commented in his own research note on quarterly results that "Kmart's surprise positive 0.5 percent comp reflects good customer response to its value pricing and layaway program. We also note ongoing margin gains on Sears Holding improved inventory management and aggressive cost cutting."

Yet, if Sears Holding has been getting a boost from cost cutting, Melich points out that it has been reducing operating expenses for some time and may not have much more to slash. Given the situation, Sears Holding needs to generate more revenue from its namesake and Kmart stores where overall sales continue to decline. Company wide comps were down 2.3% in the quarter. And a loss is a loss, even if it was smaller than expected.

Wall Street may like the better comps and continued repurchases that Sears Holding reported in the third quarter, but Melich characterizes the company as a weak retail asset. Cost cuts and what money remains on the revolver might help Sears Holding eek through another year, but they "do not address the core issues of declining relevance and underinvestment," he stated.

Skimpy capital expenditure on the store base remains a problem for Sears. "Sears Holding is on pace to spend $325 million in capex in 2009. That's $1.25/foot in total capex--we think to soften share loss, it needs to spend at least $6/foot or $1.6 billion," Melich declared in his research note.

From the perspective of the company as a retail entity, Sears Holding may not be putting its money where its interests are.

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