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SAVING SEARS

Landlords are seeing the uncertain side of America’s storied retailer

By Maura K. Ammenheuser

Following the $11 billion merger of Sears, Roebuck and Co. and Kmart Corp. this year, many real estate executives were bullish on this opportunity for two storied but struggling brands to regain ground through merchandising and marketing efficiencies.

For a while the marriage was sweet. Sears Holdings Corp.’s shares soared in the months after the deal closed in March, reaching a high of nearly $164 in July. But the sales of both retailers lagged, and when the stock fell below $140 in September, Sears Holdings CEO Edward S. Lampert took matters into his own hands. He put himself in charge of marketing, merchandising, design and online operations at both Sears and its Lands’ End unit — undaunted by the fact that his background is entirely in finance. In October, he named new executives to lead marketing, strategy and Lands’ End, all of whom will report to him.

In the process, Lampert demoted Sears Holdings CEO Alan J. Lacy to vice chairman and replaced him with former Kmart CEO Aylwin B. Lewis. Luis Padilla, president and Sears’ chief merchant, announced he was leaving at the end of October.

Lampert explained his decision in a letter posted on the company’s Web site. “My decision to become more deeply involved in certain aspects of Sears Holdings’ business reflects the board’s and my desire to make the company more responsive to our customers, and to involve me more directly in the renewal of the company,” he wrote.

Some analysts have noted that Lampert’s background is in finance, not merchandising. But experienced or not, Lampert is taking on a task that might intimidate the most seasoned retailer: the blending of two giants with shaky finances and $55 billion in annual revenues and 3,900 U.S. and Canadian stores between them.

Sears Holdings posted $13.1 billion in sales for its first full post-merger quarter (ended in July), versus $4.7 billion — Kmart’s figure — the year-ago quarter.

Kmart’s sales in 2004, the year after it emerged from Chapter 11, were $19.7 billion, versus $29.3 billion in 2002, when it declared bankruptcy. And that, in turn, was down from $35 billion two years earlier. Its comps fell steadily between fiscal 2000 through 2002 and also in 2004.

Sales at Sears were flat for years, hovering at roughly $40 billion annually from 1998 through 2003. Revenues were $36.1 billion last year. Comps shrank in recent years, as did retail sales per square foot, which dropped from $303 in 2002 to $291 last year.

Sears and Kmart have lost little market share since their merger, but both had lost plenty in past years, which they have not regained, sources say. Together, the two compete with virtually everyone, from Target to department stores to Best Buy, Circuit City, Home Depot and Lowe’s.

Considering their size, Sears and Kmart should be able to reap great efficiencies from their merger. But experts say crafting a clear identity, particularly on the Sears side, is the greater challenge. The company includes full-line Sears stores, Sears Grand and Essentials units (both of which have very similar merchandising), Lands’ End, Kmart and Kmart Super Centers and more.

Sears has morphed from catalog to retail operations, from private brands to “Brand Central” and from soft lines added in 1993 to the acquisition of Lands’ End in 1996 — and it is still tinkering. But none of this has so far sparked a major renaissance.

“Just about every year at ICSC, [Sears] was announcing another strategy or a redo of core department stores,” said Richard Hodos, president of Madison HGCD, a New York City-based retail brokerage and consulting firm. “What it said to me was it was sort of a ship without a rudder.”

Regardless of whatever niche Sears is carving, its parent company has begun cross-pollination with Kmart. Sears has its Kenmore, Craftsman and DieHard brands. Kmart has the Joe Boxer, Jaclyn Smith and Martha Stewart soft lines. By June, according to Lampert, some Kmart stores had been remodeled and were offering Kenmore and Craftsman items. He offered no details.

Observers say the chains can successfully share brands if the transition is handled properly. Martha Stewart items could do well at Sears, Hodos says, especially with a tiered structure — less expensive towels at Kmart, for instance, and more-luxurious ones at Sears.

But before Sears Holdings can tackle cross-merchandising, “they’ve got to get their logistics down,” Hodos said. Kmart has struggled with this, which helped lead to its Chapter 11 filing in the first place, he says. “They couldn’t get goods to the shelves at the right time,” he said. Kmart had cited cash-flow troubles stemming from poor sales in the final quarter of 2001 as a reason for the bankruptcy, among other reasons. Lampert has said that generating sales more evenly throughout the year at both chains is a goal.

Landlords are hesitant to comment publicly on Lampert’s more-hands-on strategy for running the retailer. But “smart landlords are always out there with a contingency plan” in case a store goes dark, Hodos said.

Sears spokesman Chris Brathwaite also declined requests for comment and interviews, referring reporters to company reports. “We don’t talk about our plans going forward,” he said.

Sears and Kmart leases will soon come up for renewal under Lampert’s scrutiny, though Kmart owns much of its real estate. “If I was a landlord I’d be very nervous,” said Tony Mullen, a retail and consumer analyst at WaveStrength Group, which publishes an investment newsletter. “He’s a tough negotiator.”

Though Lampert says he is trying to bring the company back to its retailing core, observers continue to question his motives. They wonder if the ultimate end of the Sears-Kmart story is the breakup of the company for shareholder gain rather than the creation of a thriving retail empire that is greater than the sum of its current parts.

“The question surrounding the merge is, ‘Is this just a real estate play long-term?’ ” Hodos said. To thrive as a retailer, a company must “deliver on brands’ promise every day,” he says. “If your ulterior motive is an end-run real estate game, you’re never going to execute on these tenets to run a retail organization the right way.”

So far, Lampert and company’s turnaround tactics have drawn mixed reviews. In August Sears Canada, 54 percent of which is owned by Sears Holdings, sold its 10 million-account credit card business to JPMorgan Chase & Co. Lampert ordered that most of the C$2.2 billion ($1.9 billion) in proceeds become a one-time dividend for Sears Holdings stockholders.

Mullen criticizes that decision. “It takes years to build up something that’s that valuable,” he said. “If it took you 20 years to build it, why not reinvest it in the business?”

Another of Sears Holdings new growth initiatives is the introduction of the Essentials concept, which the company calls the “most aggressive growth initiative in Sears company history.” Sears Essentials is a nonmall, 70,000-to-100,000-square-foot format combining “the best of Sears” with “convenience-inspired items,” the company says. It will carry appliances, electronics, clothes, household goods, home fashions, health and beauty items, lawn and garden products and more. Sears Holdings has opened 48 Essentials sites. Some are converted Kmarts, according to Lampert’s letter to investors.

“On the plus side, they’re trying to do something new,” Mullen said. “On the bad side, they’re experimenting.”

Essentials in particular may have to educate consumers about its everyday service items inventory, said Jack Taylor, professor of retailing at Birmingham-Southern College, Birmingham, Ala. “You don’t go to Sears to buy toothpaste and Kmart to buy riding lawnmowers.”

As for Essentials’ off-mall real estate strategies, Hodos says few new enclosed malls are in the pipeline anyway and that it makes sense for Essentials to sell appliances and home-related lines in community or power centers in rapidly growing suburbs, where people who need them are relocating and are likely to shop.

Lampert has not announced any store closings, but observers say it is inevitable. “They have a lot of overlapping store space, and I see them shedding locations,” wrote Taylor in an e-mail.

As to whether Sears Holdings can pull off any long-term retailing magic, sources are taking a wait-and-see approach.

“You’re putting two people together who each have been divorced five times — what’s the prospects?” wrote Eugene Fram, a business professor at the Rochester (N.Y.) Institute of Technology’s College of Business, in an e-mailed response to SCT. “They’ve learned a lot, but is the sixth marriage really going to make it?”

Lampert’s moves raised plenty of questions among analysts. The biggest of these, at least until he hired the executives to head strategy and marketing, was this: Can a 43-year-old financier with no background in merchandizing successfully engineer a turnaround strategy that would be challenging even for a retailing expert?

“For a man who has never run a retail chain, it sounds quite astonishing,” said C. Britt Beemer, chairman of America’s Research Group, a Charleston, S.C.-based retail consulting firm. “He’s certainly a successful businessman, and he’s bright, but there are so many issues when it comes to merchandising a retail store. You can do this and do that, but it’s the unanticipated consequences that will kill you. I’m not saying he can’t do it, but that’s a pretty big task.”

Retailing is a business best learned in the trenches, observers say. “A merchandising sense or talent is a rare commodity that takes substantial experience and insight into customer requirements, and something that can’t be taught quickly through field experience,” Fram wrote. “Unless Lampert can build a team with successful merchandising backgrounds and listen to that team, Sears Holdings will be in serious trouble.”

The stock market’s appraisal was no more positive. Sears Holdings’ shares continued to decline in the weeks after Lampert’s reshuffle, dropping to $114 in mid-October.

Beemer, for one, is unimpressed. “I think they would have been much better off hiring a top-flight merchandiser who really understands the whole strategy of retailing,” he said. “It’s typical of what Kmart has done over the past few years, which has been to run things by the seats of its pants rather than having any proactive strategy.”

— Curt Hazlett contributed additional reporting to this story.

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