Sears Holdings: What Investors Are Missing

After another supposedly weak quarter for the company, the stock of Sears Holdings Corporation  had a surprising rebound. The retailer, in the middle of a shift toward online sales and asset spinoffs, had some interesting takes that the typical bearish investor may have missed.

Sure the company spent the quarter spinning off Lands End and this, along with store closures and weak Sears Canada results, sent sales down over the prior-year period. Even worse, adjusted EBITDA declined further in the first quarter to reach a loss of $221 million, compared to a loss of $26 million last year. Despite these numbers and a horrendous domestic retail environment that resulted from weak consumer spending and bad weather, Sears Holdings had some relatively constructive numbers hidden in the details.

Some trends suggest that the retailer is starting to gain traction and may gain staying power from new initiatives. The slide from Sears below highlights the improving trends hidden under all of the shifts in assets and store closures:

Source: Sears Holdings Q1 2014 Presentation

Positive comps
Possibly the most surprising number from the first-quarter earnings report was that Sears Domestic experienced comparable-store sales growth of 0.2%. It achieved the number despite the continuing weakness in the retail sector and a winter with a polar vortex that disrupted all but the strongest retail operators. On top of that, chief mall rival J.C. Penney Company is experiencing a solid rebound in business after a disastrous couple of years that likely recaptured customers from Sears.

Sears' total comparable-store sales declined a meager 1% due to the continued weakness at Kmart stores, which were down 2.2% for the quarter although the numbers were better than they were last year. J.C. Penny produced 6.2% comp-sales growth. As with Sears, the rebound in sales still left the company short of profits.

Membership gains
The move toward focusing on a member-centric business model instead of the store-based network is starting to pay off. The company now obtains 74% of eligible sales from Shop Your Way members, up from 68% during the first quarter of 2013. The company continues to see increased point redemptions and this has led to a very engaged customer base. The program has led to higher costs in the short term as Sears continues to build out the loyalty-rewards systems.

The program cost $38 million in the first quarter and the increased points promotions lowered Sears' gross margin somewhat, but the company expects to transfer 1 million active members over to the highly active status and generate over $50 million in incremental EBITDA. Shifting 10 million users over would increase EBITDA by $500 million.

Costco Wholesale Corporation uses a membership base of over 40 million households and 73 million cardholders to rack up impressive returns. In the last year, it has garnered over $2.4 billion in revenue from membership fees alone and this highlights the benefits of a strong program.

Those members continue to push comparable-store sales higher for Costco with April producing 5% gains in domestic warehouses.

Online growth
A key reason for the comparable-sales growth at Sears Domestic and the strong ties to Shop Your Way members has been the success of online sales. For the quarter, online and multi-channel sales grew by 26%. For the last five years, the compound annual growth rate equals 19%.

Not to be outdone, J.C. Penney saw online sales surge nearly 26% as well.

Bottom line
Clearly, the retail story hasn't improved to any significant degree but Sears Holdings now has something besides its real estate and its brand to offer investors. The news regarding online sales and membership gains and the surprisingly solid comp sales do provide hope that the company can reduce the bleeding from operations and possibly develop a long-term retail strategy. Investors should be prepared for more store closures and square footage reductions, but the shift to online will provide more non-mall sales going forward.

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Mark Holder and Stone Fox Capital clients own shares of Sears Holdings. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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