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Sears: It's a Discount Store, Not a Hedge Fund

A store is a store, not an investment vehicle. Proof of this comes via the miserable quarter Sears Holdings just posted, capped by a $56 million loss. Comps at Sears stores fell 9.8 percent, while same-store Kmart sales were down 7.1 percent, in a quarter when other discounters (Costco and Wal-Mart, for starters) picked up share.

Analysts called the loss a surprise, but anybody who's walked through a Sears or Kmart saw it coming. Here's the word on the real street, Main Street, via Sears-Kmart's consumer site, sk-you.com, which asked, "How can we improve our stores?"

From Boise, Idaho: "Sears stores are just plain dull. I don't ever feel like browsing. I just go to get what I need, then leave."

From Rainbow City, Ala.: "I went in a few days ago hoping to purchase a GPS system that was in your ad, could not find it and I ask about it and the sales associate told me that the store did not get any in, and went about her business, did not offer to show me another brand or what the store had in stock."

From Crossville, Tenn.: "The atmosphere is not someplace where you want to spend a lot of time and this is a minus for you because as you know, money is not spent if you're in and out of a store."

An employee from Teaneck, N.J.: "It would also help our credibility to have more than one unit of an advertised item on hand when an ad breaks. This really annoys our customers."

When Edward Lampert's ESL Investments took a 49.6 percent share of Sears in 2005, Wall Streeters cheered. Finally, the troubled retailer would be managed with financial discipline. But retail analysts shook their heads. You can't run a discount store like a hedge fund, they said. Guess who turned out to be right?

Lampert's strategy was to rein in capital expenses, keep inventory moving through discounting, and reinvest the free cashflow. That stopped working in late 2007, as consumer spending dried up and went elsewhere.

Instead, EBITDA fell 65 percent year-over-year to $208 million in the quarter ended May 3. "With cash flows dwindling, investors have to consider the direst scenario," the Wall Street Journal's Peter Eavis writes. "Wall Street analysts are. If Sears's sales and cash flows continue declining at their current pace, by early next year suppliers will likely wonder whether the company has the cash to pay them, Morgan Stanley analyst Gregory Melich said."

At the end of 2007, Lampert's chairman's letter justified the company's focus on stock buybacks as a more appropriate use of capital than store improvements.

"Some have wondered why we haven't invested more money in our stores. This is a legitimate question. In theory, a company can always invest more money in its operations, but, when we make an investment we expect to earn an appropriate return." It may be time for Lampert to rethink this strategy.

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