Sears Holdings: Slicing the Trade Payables Pie
Sears Holdings’ (NYSE: SHLD) financial condition appears more challenged than ever given its mounting debt load, shrinking asset portfolio, and ongoing operating losses. While Sears’ management stated it is seeking $1.25 billion in annualized cost reductions, it’s unclear if the company can actually reduce its large cash burn so significantly. Given the unstable financial picture, now is an important time to evaluate the company’s liquidity, particularly regarding merchandise payables.
CreditRiskMonitor serves commercial credit and corporate supply chains and specializes in identifying high-risk public companies prior to financial distress and bankruptcy. The CreditRiskMonitor customer base provides more than $110 billion in trade payables every month that is assessed, prioritized, and monitored for account-receivable dollar-risk exposure. Trade payables are an extremely important form of external financing for corporations, and CreditRiskMonitor closely tracks this data on a company-by-company basis.
Sears’ working capital position has declined sequentially in each of the last four quarters, falling from $1.5 billion to $127 million by the first quarter of 2017. As a part of working capital, trade payables are an important factor in determining whether or not this retailer can sustain operations. In the fourth quarter of 2016, Sears Holdings reported a 33 percent year-over-year decline in trade payables, which was far greater than its 17 percent decline in sales revenue.
The first quarter report showed a similar pattern, with revenue dropping 20 percent on a year-over-year basis, but this was still less than the 28 percent drop in trade payables. The sales decline is driven by store closures and negative same-store sales, which fell 11.9 percent. But the question remains: Why are trade payables declining at an even faster rate than sales? It may be a working capital squeeze.
CreditRiskMonitor’s trade payables data sample for Sears reveals a similar development to what was reported by the company. Across the CreditRiskMonitor data sample, the first quarter saw an average decline of 48 percent in trade payables year-over-year. This drop was worse than the actual 28 percent figure, which in part reflects that CreditRiskMonitor does not collect all of the company’s trade data. However, the trade payables sample was indicative of the trend and pointed to the large decline in advance of the quarterly report.
Creditors that report merchandise payables to CreditRiskMonitor also shrank by 31 percent year-over-year. This decrease means suppliers who contribute payment data to CreditRiskMonitor are, at the very least, directionally reducing their exposure to Sears. The bigger problem, however, would be if vendors are also deciding to cut their exposure entirely.
A Quirky Year
There have been a few headlines regarding Sears’ supplier base over the last year. For example, in October 2016, JAKKS Pacific (NASDAQ: JAKK) made a major decision to stop supplying its toy inventory to the retailer. More recently, One World, which makes power tools under the Craftsman brand, became agitated by Sears’ low purchasing prices and attempted to sell to other companies that were offering better terms. As of June 2017, Sears’ management claims to have “resolved” the issue. However, another source announced that Sears is suing another Craftsman supplier, Western Forge, over a potential agreement breach. All of these events clearly illustrate the anxiety among Sears’ supplier base.
Over the last four quarters, merchandise payables have declined by 29 percent on average relative to last year’s comparisons, much greater than the average decline in sales revenue of 15 percent. For the first quarter, merchandise payables slipped from $1.34 billion to $961 million year-over-year, the lowest level realized to date.
Sears reported a profit for the first quarter due to the sale of its Craftsman brand. It also managed to extend the maturity on its secured loan facility from July 2017 to January 2018, giving itself some breathing room. However, poor quarterly operating performance appears relatively unchanged, and Sears’ liquidity shows increasing signs of weakness. Part of the risk attached to Sears’ working capital position is its supplier-based funding via traditional payment terms, something that is directionally unstable.
As it stands, Sears will need to refinance existing loans and monetize additional assets if it plans to avoid financial distress over the next twelve months. Sears has managed to pay its bills thus far, but risk is discernibly high. Overall, it appears that Sears’ supplier base will determine whether the company’s financial condition experiences a moderate or accelerated decline. Our trade payables data and Sears’ financial statements suggest the latter.
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