VideoRESOLVING THE DISPUTE
Sears agreed to settle the dispute. And the $320 million aftertax cost of the $475 million that the company has set aside for the entire liability comes to a whopping 80 cents per share for the second quarter of 1996, or 73 percent of its earnings for the quarter. But analysts applaud Sears's chairman and CEO, Arthur Martinez, for forthrightly tackling the problem. They say he wisely decided that the remaining reaffirmation balances were not worth the potential public relations damage that might follow if Sears fought the issue in court. After all, it was only five years ago that Sears was caught red-handed for overcharging customers in its auto repair business.
But are Sears's problems with reaffirmations over? Many analysts think so. "For all practical purposes, other than a diminished ability to obtain reaffirmations, it is," says David Poneman, an analyst at Sanford C. Bernstein & Co., in New York. But some caution that the matter won't be fully put to rest until all payments have been confirmed and paid out.
To limit losses on reaffirmations, Sears may have to accept a lower price in its negotiations with the consumer, explains Edward Kimmel, principal in the Washington, D.C., law firm of Hambright & Kimmel and legal counsel to a number of consumers facing Sears in bankruptcy court. Kimmel suspects that Sears may have avoided filing some reaffirmations in the past because the terms in those cases were probably more favorable to the debtor than Sears's standard offer.
By making such deals public with a court filing, Sears risks tipping off other debtors that it is willing to accept a lower figure for allowing debtors to keep their merchandise and their credit cards, Kimmel says. So, depending on the outcome of pending court cases, Sears's credit card business could become less profitable than it currently is. Not only will Sears no longer be able to dun deadbeats as easily as it did in the past, but its dependence on reaffirmations may increase even as it earns less from them. Remember: While the $40 million in "bad" reaffirmations that Sears is forgoing under the court settlement represents only 5 percent of the $750 million that analysts estimate the company currently earns from credit cards, bankruptcies continue to mount.
ANATOMY OF A TURNAROUND
So how have investors responded to all this? They've bid up the stock from about $30 at the start of Martinez's reign to a high of $65.50 recently. Is the market missing something? Not really, says Poneman. Sears is "offsetting skyrocketing losses [in credit card write- offs] with skyrocketing revenues," he says. As a result, Poneman and other analysts expect Sears's overall earnings growth to continue to exceed its annual target of 15 percent unless there is a recession.
That says a lot about Sears's turnaround. It was, after all, only five years ago that the proud retailer was closing stores amid predictions of its impending demise. Its domestic merchandising profits, then separately reported, were a paltry $64 million in 1992, a fifth of what it earned from its U.S. credit card operations.
But Sears's financial health has come a long way since then. A former head of merchandising at Sears, CEO Martinez is credited with turning around the retailing operation after his predecessor, Edward Brennan, refocused the company by jettisoning noncore financial services subsidiaries, including The Allstate Corp.; Coldwell Banker; and Dean Witter, Discover. After closing down the storied but dowdy catalog business, Martinez revamped the retail operations' merchandising mix to focus on women's apparel and other "soft goods," which carry higher margins than hard goods, and backed the effort up with jazzy marketing. Consequently, Poneman predicts that merchandising profits this year will account for more than Sears's credit card earnings for the first time since 1989.
Analysts also point to a dramatic decline in sales, general, and administrative expenses (SG&A), as an indication of merchandising's rebound. In 1992, when such figures were broken out separately by Sears for its merchandising operations, SG&A was at a worrisome 28.5 percent. SG&A in the second quarter was estimated most recently by Sears at only 20.4 percent--a stunning eight percentage point drop.
Granted, Sears's method of reporting may overstate the gains. Current accounting includes credit card operations in the calculation, whereas previous accounting did not, and credit card SG&A is a much smaller percentage of revenues than are merchandising costs. Another problem with the 20.4 percent estimate is that it includes significant gains in total revenues without any gains in SG&A costs. That's also due to the new accounting, which was prompted by a new rule issued by the Financial Accounting Standards Board that went into effect last January 1. The rule requires Sears to immediately account for much of the gain from securitizing its credit card receivables rather than spreading the income across the life of the asset-backed bonds that generate the cash flow. So Sears's SG&A and, indeed, the progress of its turnaround, are benefiting from an accounting change the effects of which will diminish after this year.
And Sears is by no means invulnerable to a sharp jump in personal bankruptcies. Sears's charge-offs for bad loans spiked last year, catching management by surprise. As a result, some analysts contend the problem could throw a monkey wrench into their earnings projections for Sears. The issue, says L. Wayne Hood, an analyst for Prudential Securities Research, in Atlanta, is a "wild card."
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