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Sears Holdings: Likely To Hold On Until At Least Mid-2017Sears Holdings: Likely To Hold On Until At Least Mid-2017

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Dec. 27, 2016


Despite its substantial losses, I think Sears is likely to avoid a filing until at least mid-2017.

The two year anniversary of the Seritage transaction is in July 2017, meaning the federal statute of limitations with regard to fraudulent conveyance should run out then.

As well, seasonal changes in inventory levels plus significant numbers of store closures could result in inventory conversion offsetting cash burn from Q4 2016 to Q2 2017.

Q3 is typically Sears's worst performing quarter based on adjusted EBITDA, so cash burn plus inventory build could mean Sears needs $1+ billion to get through Q3 2017.

Thus Sears can probably survive without additional funding or asset sales until mid-2017, but then needs to raise $1+ billion after that point.

While Sears Holdings (NASDAQ:SHLD) is trading at its lowest level since 2003 now, I think that any potential bankruptcy filing is unlikely to happen until at least mid-2017 or later. Filing after that point removes some potential legal challenges related to the Seritage transaction, while seasonal changes in inventory levels plus inventory conversion to cash from closing stores can probably offset Sears's losses up to Q2 2017. After that point, Sears will likely need to find $1+ billion in order to make it through the 2017 holiday season (even allowing for around 250 store closures in December 2016 and 2017).

Seritage Transaction

It has been discussed that Sears is unlikely to file for bankruptcy until the second half of 2017 at the earliest due to the statute of limitations on fraudulent conveyance related to its July 2015 Seritage transaction. The federal statute of limitations is two years for fraudulent conveyance, although some state statutes of limitations are apparently as long as six years.

I am inclined to agree that Sears is unlikely to file for bankruptcy before July 2017 due to the above item, plus the typical conversion of inventory to cash between Q3 of one year and Q2 of the following year. Despite Sears's poor business performance, it can potentially make it from Q3 2016 to Q2 2017 without depleting its remaining cash position.

Seasonal Inventory Changes

During the past two years, Sears's net inventory position has decreased by $574 million and $709 million respectively between Q3 of one year and Q2 of the following year. This includes roughly $1.5 billion in lower inventory levels as the peak holiday season inventories get reduced, and is partially offset by a roughly $850 million reduction in merchandise payables.

$ Millions

Q3 2015

Q2 2016

Merchandise Inventories



Merchandise Payables



Net Inventory



$ Millions

Q3 2014

Q2 2015

Merchandise Inventories



Merchandise Payables



Net Inventory



During these two periods, Sears has also closed on average roughly 110 stores during each period, so the net inventory decrease also includes the effect of the inventory reduction from store closures.

2017 Inventory Levels

Sears has already indicated that around 64 Kmart stores are being closed in December, and also mentioned while discussing its Q3 2016 results that it plans to continue to accelerate store closures. Hypothetically, if Sears closed an additional 190 stores before the end of Q2 2017, its inventory situation could look like the following. This assumes that merchandise payables are just over 28% of merchandise inventories at the end of Q2 2017, compared to nearly 29% at the end of Q2 2016 and nearly 31% at the end of Q3 2016.

$ Millions

Q3 2016

Q2 2017

Merchandise Inventories



Merchandise Payables



Net Inventory



Sears's cash position could be improved by approximately $1.056 billion in this situation due to inventory changes.

Q3 Is A Tough Quarter For Sears

Adjusted EBITDA between Q4 2015 and Q2 2016 (three quarters) was negative $509 million, while Q3 2016 was negative $375 million. Typically Q3 has been the worst quarter for Sears based on adjusted EBITDA in addition to being the quarter where it needs to build up inventory for the holidays.

With approximately $200 million per quarter in combined interest costs, pension plan contributions and capital expenditures, Sears may burn around $1.1 billion (excluding working capital changes) between Q3 2016 and Q2 2017 including negative $500 million in adjusted EBITDA. This number is fairly close to the $1.056 billion in contributions from reduced inventory levels between Q3 2016 and Q2 2017 in the scenario outlined above. Thus, Sears can probably figure out a way to keep afloat until July 2017 without needing additional asset sales, and relying on store closures and managing inventory instead.

The situation changes in Q3 2017 since net inventory will likely increase by $400 million to $500 million compared to Q2 2017. As well, the negative $375 million adjusted EBITDA (at Q3 2016 levels) combined with the $200 million per quarter in other costs could result in Sears needing to make up a shortfall of $1+ billion in Q3 2017. That requirement makes Q3 the most likely time for Sears to file for bankruptcy if it can't raise the money it needs to get through 2017.

The Vendor Factor

One thing to keep an eye on for Sears though is whether its merchandise payables as a percentage of merchandise inventory continues to decrease. This number is currently around 5% to 6% lower than in 2015, which was already a few percent lower than 2014 and could be an indication of shorter payment terms.

Sears has previously outlined its case for why quicker payments to vendors are not a bad thing, especially since it often will gain discounts or other benefits for doing so. Others believe that Sears is being forced into quicker payments by supply chain pressure though, and there are reports that some vendors may be asking for cash in advance now. Another 5% decrease in merchandise payables as a percentage of merchandise inventory would negatively impact Sears's working capital by around $170 million (based on estimated Q2 2017 inventory levels).


I believe that Q3 is the most likely quarter for Sears to file for a bankruptcy. Whether that filing happens in Q3 2017 or some other Q3 beyond 2017 depends on whether Sears can rustle up over $1 billion in asset sales or other funding before then. However, a filing before Q3 2017 seems fairly unlikely to me.

One reason is that the federal statute of limitations for fraudulent conveyance related to the Seritage transaction runs out before Q3 2017. While some state statues of limitations as long as six years, Sears probably doesn't have the ability to last that long. It should however be able to make it to Q3 2017 as closing a couple hundred more stores should allow it to reduce inventory levels (combined with seasonal fluctuations) enough to offset its cash burn from Q3 2016 to Q2 2017.

Q3 2017 is much more challenging for Sears because of seasonal inventory build plus it is typically the worst performing quarter for Sears based on adjusted EBITDA.

An x-factor is the demands placed by vendors on Sears for payment. Merchandise payables as a percentage of merchandise inventories have generally been declining, and if that continues, Sears may lose a couple hundred million of its net inventory benefit to its cash position. Such a situation is probably manageable for the next few quarters unless it gets extreme though.

As well, these calculations are based on Sears's adjusted EBITDA not getting significantly worse in Q4 2016 to Q2 2017 compared to Q4 2015 to Q2 2016.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.