Lampert Makes Case as Sears Holdings Profits Crash

Hoffman Estates, Ill. — Released alongside drab financial news from Sears Holdings was the annual "Message from the Chairman" by Edward Lampert, in which he acknowledged setbacks but made the case for the future of the combined 3,800-store Sears and Kmart business.

"In 2008, we need to reverse much of the profit erosion we experienced in 2007. It won't be easy, especially if the economy stays soft," Lampert admitted in the note.

Sears Holdings reported annual net income of $826 million for the year ended Feb. 2, down 44.6% from $1.5 billion in the year prior. In the fourth quarter, earnings of $426 million fell 47.5% from $811 million a year ago.

Sears Holdings sales of $50.7 billion for 2007 were down 4.3% from $53.0 billion in 2006. That was equal to the drop in comp-store sales: negative 4.3%.

Lampert pointed out that the retailer had entered 2007 with substantially larger inventory than in the past, in order to prepare for top line gains. Timing was poor, however, and the economy has brutalized margins. "As a result," Lampert noted, "our gross margin dollars declined by more than $1 billion from the prior year."

Indeed, while the company flattened or slightly reduced selling and administrative costs in dollars, the SG&A rate as a percentage of revenues rose 80 basis points to 22.6% in 2007 — while the gross margin rate fell 100 basis points to 27.7%.

In his letter, Lampert posted two tables of comparative financial statistics of retail companies with market capitalizations over $5 billion, one highlighting return on investment since May 2003 (when Kmart exited bankruptcy) and the other showing debt over time and cash on hand.

Sears Holdings compares favorably in both tables.

"However, our profit margins continue to lag our competitors," Lampert acknowledged. So too, does top-line growth. Analysis by HTT of retail sales growth from fiscal 2005 through 2007 shows Sears Holdings is last in class among key competitors (see chart, sales in billions.)

To its credit, Sears Holdings has a strong cash position and has cut its debt; the company has also reduced its legacy pension obligations.

Among positive initiatives, Sears Holdings will add Lands' End shops to more stores in 2008. Lampert noted that the Land's End division grew earnings by 12% in 2007.