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Sears Downgraded on Weak 2Q

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Based on the company’s weaker-than-expected quarterly results, we have downgraded our long-term recommendation on Sears Holdings Corporation to ‘Neutral’ from ‘Outperform’. Moreover, the company has a Zacks #3 Rank implying a short-term Hold rating.

Sears Holdings reported second-quarter fiscal 2012 adjusted loss of 86 cents per share, wider than the Zacks Consensus Estimate of a loss of 84 cents per share. Moreover, the company’s net sales of $9,467 million declined 6.6% from the prior year, missing the Zacks Consensus Estimate of $10,138 million. The decline in quarterly revenue not only reflects lower domestic comparable store sales, but also reduced Kmart and Sears full-line stores in operation during the quarter.

However, on a year-over-year basis, Sears’ loss per share narrowed from the prior-year quarter’s loss of $1.18. The improved results were primarily driven by the strategies it has undertaken to reduce cost and strengthen liquidity along with inventory management and merchandise initiatives.

In addition, we believe sluggish discretionary spending and intense competition amid rapidly changing customer preferences is also undermining the company’s future prospects. Moreover, Sears Holding’s financial performance may be substantially affected due to its significant presence in international market, which exposes it to unfavorable foreign currency translations, economic or political instability and other governmental actions on trade and repatriation of foreign profits.

Sears has been grappling with weak top-line performances and weaker bottom-line results. However, the measures undertaken to revive the operating performance are showing some signs of improvement, which is evident from the company’s margin expansion and narrower loss per share from the prior-year quarter.

Adjusted EBITDA for the second quarter of fiscal 2012 was $153 million, compared with $58 million in the prior-year quarter. However, EBITDA margin expanded 100 basis points to 1.6% from 0.6% in the prior-year quarter.

In an effort to optimize its financial performance, the company recently announced a string of measures to enhance its growth prospects by lowering investment in different sections that no longer contribute significantly to its growth.

In addition to this, the company is focusing on cost containment, inventory management, and merchandise initiatives to improve margins through leverage on buying and occupancy expenses.

Sears Holdings is one of the largest broad line retailers in the U.S. The company operates a strong network of over 4,000 full-line and specialty stores across the U.S. and Canada to compete effectively against rivals, such as Wal-Mart Stores Inc. (WMT - Free Report) , Target Corporation (TGT - Free Report) and Home Depot Inc. (HD - Free Report) .

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