Updated March 25 at 6:25am

Sears distressed as investors reject closings


NEW YORK - Sears Holdings Corp.’s bonds have crossed into distressed territory as its plan to close as many as 120 locations - but none in Rhode Island or Massachusetts - may fail to stem more than four years of declining sales and prevent it from using up cash as profitability wanes.

The extra yield investors demand to hold Sears’ debt instead of Treasuries has breached the 10 percentage-point level traders consider as distressed, double the spread at the end of 2010. Credit-default swaps on its finance unit are at about the highest level since 2008, as Fitch Ratings cut Sears’ rating and Standard & Poor’s gave the retailer a “negative” outlook.

The Hoffman Estates, Ill.-based company, which sells goods from cosmetics to washing machines at Sears and Kmart stores, is struggling to create a plan to restore profitability. Shares of the largest U.S department-store chain fell 31 percent last week after CEO Edward Lampert announced the cost-cutting plan Dec. 27.

“The way the business is being run now is not sustainable,” Bonnie Baha, the head of the global developed credit group at DoubleLine Capital LP, which oversees $21 billion, said in a telephone interview from Los Angeles. Sears has put itself “in a precarious position, especially absent a focused business plan, about what sort of a retail operation they want to be,” she said.

Falling Bonds

The retailer’s $987.4 million of 6.625 percent notes due October 2018 fell as low as 74 cents on the dollar on Dec. 27, the least since they were issued in exchange for other debt in August, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority. The debt yielded 11.9 percent at 10:55 a.m. today.

Sears had $4.55 billion of outstanding borrowings on Oct. 29, according to a regulatory filing. That included $2 billion of notes and debentures and $1.65 billion of secured borrowings.

Kimberly Freely, a Sears spokeswoman, didn’t respond to a voicemail message seeking comment on the movement in the company’s bond.

Spreads on Sears widened to 10.68 percentage points on Dec. 31 from 5.02 percentage points at the end of 2010, according to Bank of America Merrill Lynch index data. That compares with 7.27 percentage points for B rated debt, up from 5.46 percentage points.

Default Odds

Investors now consider Sears’s credit to be virtually on par with that of novelty retailer Spencer Spirit Holdings Inc., which had a spread of 10.65 percentage points, the data show.

Credit-default swaps on the retailer, which rise as investor confidence deteriorates, climbed almost 17 percentage points to 31.8 percent upfront in December, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. That’s in addition to 5 percent a year, meaning it would cost $3.18 million initially and $500,000 annually to protect $10 million of Sears’s debt.

Those levels imply the market perceives a 77 percent chance Sears will default within five years, based on a 40 percent recovery expectation, according to a standard pricing model maintained by CMA. That’s up from 47 percent odds at the end of October. The contracts pay face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

“The Sears brand has been so damaged by mismanagement that they may have alienated a whole generation of shoppers,” said Craig Johnson, president of consulting firm Customer Growth Partners in New Canaan, Conn. “Their value is deteriorating by the month. They need new ownership and a new strategy.”

Cash Flow

Adjusted fourth-quarter cash flow will be less than half 2010’s $933 million, with same-store sales falling 5.2 percent in the eight weeks ended Dec. 25, Sears said in a Dec. 27 statement. Department-store sector sales overall climbed 4 percent in November and December, according to an estimate from the International Council of Shopping Centers, a New York-based trade group.

Closing stores will generate as much as $170 million of cash from inventory sales and leasing or sales of the locations, the company said. Sears will incur non-cash expenses of as much as $2.4 billion to write down the potential tax benefits and goodwill, and plans to reduce fixed costs by $100 million to $200 million.

“While expense cuts and store closures are a step in the right direction, the strategic direction of Sears remains an unanswered question” James Goldstein, an analyst at bond researcher CreditSights Inc. in New York, said in a note to clients dated Dec. 28 that maintained an “underperform” rating on the company’s debt.

‘Risk of Restructuring’

Fitch cut the company’s debt ratings to CCC from B, citing the possibility that earnings before interest, taxes, depreciation and amortization may turn negative next year. That would force Sears to fund itself with more debt, analysts led by Monica Aggarwal in New York wrote in a ratings statement. Fitch estimates the retailer’s leverage will climb to at least 8 times this year from 4.6 times in 2011.

“If Sears is unable to access the capital markets or find other adequate sources of availability, and Ebitda remains at the current rate or lower, there is a heightened risk of restructuring over the next 24 months,” Aggarwal wrote.

S&P put its B rating on CreditWatch, forecasting deteriorating credit metrics and below-expectation performance this quarter.

Maturing Debt

“The company has underinvested in its stores base, especially when compared with its peers,” New York-based S&P analysts Ana Lai and David Kuntz wrote in a Dec. 28 note.

The retailer has $130 million of bonds coming due next year, according to data compiled by Bloomberg. It has $317 million of term loans and has drawn $515 million of its $4.2 billion of revolving credit lines, all of which mature by April 2016, the data show.

Though the debt calendar is manageable, a history of rewarding shareholder “has damaged their credibility, and if the vendors lose confidence and are hesitant to ship merchandise, that becomes very problematic,” Baha said. “They don’t have too many more bullets left.”

Sears’ net loss widened last quarter to $421 million from $218 million a year earlier, the company said in a Nov. 17 statement. Sales fell 1.2 percent to $9.57 billion, led by Canadian stores. Sears’s stockpile of cash and near-cash items fell to $624 million at the end of October from $1.38 billion in January last year, Bloomberg data show. It spent $163 million to repurchase shares in 2011, it said in the statement.

Cash Drain

The company previously repurchased $5.8 billion of its stock since Lampert merged Kmart and Sears in 2005.

“Eddie Lampert sucked cash out of the company,” Johnson said. By rewarding shareholders instead of reinvesting capital, “management killed the goose that laid the golden egg,” the company’s megabrand that created the modern department store, he said.

Sears named Ron Boire as executive vice president, chief merchandising officer and president, the company said in a statement today. He was previously president and CEO of Brookstone Inc.

The retailer will increase investments in its best- performing stores, according to CEO Lou D’Ambrosio.

‘Restore Greatness’

“We’re going to take whatever actions will be necessary to restore greatness to this company,” D’Ambrosio said in a telephone interview. Sears’s assets are “undervalued, which creates an opportunity,” he said. “Sears is an iconic brand. It’s important to revitalize this company.”

The company’s shares fell almost by half last month, compared with a 1.5 percent rise at Wal-Mart Stores Inc. and a 0.5 percent decline at Macy’s Inc. Last week’s 30 percent decline was the biggest slump since at least 2003. The shares fell 0.3 percent today to $31.675 as of 11:56 a.m. in New York.

“Besides companies who have gone bankrupt, I can’t point out any retailers who have had such a decline as Sears,” Gary Balter, an analyst at Credit Suisse Group AG in New York, said in a telephone interview, forecasting problems at least through Feb. 23 when it reports fourth-quarter earnings. “Their real estate simply isn’t going to do the trick and pull them out of this rut,” he said.


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