So there was an article out last week that brought up the issue of Sears Holdings (SHLD) and its balance sheet. It focused on Sears credit revolver and its upcoming renewal in 2010. It also misses the point.
First, here is the article. For those who do not want to read the whole thing, here are the main points in it.
Disregard the reported fourth-quarter profits, when Sears earned $2.94 a share. The company is expected to post quarterly losses in the coming three quarters, which are seasonally weaker; that’s likely to pressure EBITDA levels, which have been falling steadily for a few years. Coupled with the expiration of a March 2010 $3.8 billion credit revolver, poor EBITDA could bring the spotlight to the company’s balance sheet.
Although that revolver doesn’t need to be replaced for another 12 months, the company will need to line up a replacement later this year, ahead of the peak working capital needs during the holiday season. (In fiscal 2008, Sears tapped roughly $3.0 billion of the revolver, and the company can ill afford to risk coming up against the revolver’s limits this time around, which would appear to be the case in light of still-negative comps that will likely pressure cash generation for months to come.)
Let’s look. From Sears recent 8-K, “Reduced total short-term borrowings on our $4.0 billion revolving credit facility from $1.9 billion at November 1, 2008 to $435 million at January 31, 2009”. The “tapping” of the credit facility is done for inventory purposes and then is paid off as that inventory is sold.
Regarding inventory, from the same 8-K, “Merchandise inventories were approximately $8.8 billion at January 31, 2009 as compared to $10.0 billion at February 2, 2008. Domestic inventory levels declined from $9.1 billion at February 2, 2008 to $8.1 billion at January 31, 2009 despite the addition of $120 million of Kmart footwear inventory which was added when Kmart began operating its footwear department in January 2009. Inventory levels at Sears Canada decreased $181 million, largely due to the impact of foreign currency exchange rates.”
Back to the piece. It goes on to say more store closings and less share repurchases would have avoid Sears being in this situation, then this:
How much EBITDA Sears can generate this year has important implications for the retailer’s efforts to replace that $3.8 billion credit revolver. Sears’s EBITDA fell from $2.55 billion in fiscal 2008 to $1.6 billion in fiscal 2009, and a drop of a similar magnitude this year would be a big problem. For example, the retailer needs at least $500 million simply to support interest payments and maintenance capex. With little cash available to support other badly needed investments in the store base, the retailer’s competitive positioning — already weak — could weaken yet further.
As Sears looks to replace that revolver, it appears that it will be hard to secure an additional $3.8 billion line. Yet as noted above, Sears needs nearly that much money to support seasonal working capital needs (which peak in November). Securing a smaller revolver may not be an option, which may lead the retailer to sell good assets such as the Land’s End catalog business, one of the few jewels in the empire. Suffice it to say a revolver that is far smaller could lead to a severe liquidity crisis
Scary right? Well, not if you undestand the credit agreement and how it is usd. Let’s look.
From the December 2008 10-Q
We have a $4.0 billion, five-year credit agreement (the “Credit Agreement”) in place as a funding source for general corporate purposes, which includes a $1.5 billion letter of credit sublimit. The Credit Agreement, which has an expiration date of March 2010, is a revolving credit facility under which Sears Roebuck Acceptance Corp. (“SRAC”) and Kmart Corporation are the borrowers. The Credit Agreement is guaranteed by Holdings and certain of our direct and indirect subsidiaries and is secured by a first lien on our domestic inventory, credit card accounts receivable and the proceeds thereof.
Availability under the Credit Agreement is determined pursuant to a borrowing base formula, based on domestic inventory levels, subject to certain limitations. As of November 1, 2008, we had $1.9 billion of borrowings and $1.0 billion of letters of credit outstanding under the Credit Agreement with $1.1 billion of availability remaining under the Credit Agreement.
The $1.9 billion in borrowings, borrowed in the first nine months of fiscal 2008, are classified within short-term borrowings on our Condensed Consolidated Balance Sheet as of November 1, 2008 as we expect to repay the entire $1.9 billion of borrowings in December 2008 (although we do expect to borrow on the revolver again in the month of January 2009). The Credit Agreement does not contain provisions that would restrict borrowings or letter of credit issuances based on material adverse changes or credit ratings.
Our $4.0 billion Credit Agreement is funded by a consortium of banking entities, including an affiliate of Lehman Brothers. This affiliate has a $207 million total commitment in the $4 billion revolving credit facility, but since September 17, 2008 has not funded its proportionate share of our borrowings under the facility.
The majority of the letters of credit outstanding under the Credit Agreement are used to provide collateral for our insurance programs.
Here is the actual agreement.
Borrowing Base” means, at any time, an amount equal to (a) 85% of the aggregate outstanding Eligible Credit Card Accounts Receivable at such time plus (b) the lesser of (i) 70% of the Net Eligible Inventory at such time minus 100% of Other Borrowing Base Reserves and (ii) 85% of the Net Orderly Liquidation Value at such time. The Agent may, in its Permitted Discretion and with 5 days notice to the Borrowers, reduce the advance rates set forth above or adjust one or more of the other elements used in computing the Borrowing Base.
As the 10-K above says, borrowing of it are “inventory based”, not based on earnings
Disclosure (“none” means no position):Long SHLD
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