Sears Holdings is the structurally weakest ~$30 billion retailer in America, as its secular shift from the mall to off-mall box retailers has caused significant share loss, notes Evercore.

Sears Holdings (SHLD) -Bear Case Is Zero: Evercore

After wading through Sears Holdings’ latest 10-K filings, Greg Melich and his team at Evercore expressed their biggest concern at the retailer’s exceptionally high rate of FCF burn which actually accelerated in 2014 compared to the previous year.

Sears experiences tight liquidity

The Evercore analysts note Sears Holdings had $1.15 billion in available liquidity at the end of the fourth quarter. The analysts believe this would be sufficient to fund the first quarter but that the retailer would need additional external funding in the second quarter, barring an internal event such as wholesale inventory liquidation.

The analysts believe the rapidly shrinking retailer will also not be able to fund the 2015 holiday inventory build without external funding sources. They point out that the retailer’s payable days outstanding dropped from 33 to 25 in 2015. Moreover, the retailer’s current revolver expires in April 2016, and the retailer has indicated in its 10-K filing that it is in discussion with its bankers to “extend or replace” the facility.

Melich and team note that the actual structure of the company’s REIT will be known when the retailer files its Form 10 or S-1, though the retailer has reiterated its REIT transaction would yield $2 billion and be completed in May or June. The analysts’ basic REIT math assumes rents at $4-5/ft, an 8% cap rate, 250 stores, and store sizes of 136,000 to 155,000 feet for a value between $1.9 billion and 2.2 billion.

Based on their estimates, the analysts have come out with a few scenarios, including placing 250 of the best stores in the REIT, getting $2 billion in cash and that this is sufficient to fund the business for two years to get past fraudulent conveyance statutes. The following graph captures the analysts’ various scenario analysis:

Sears-Scenario-analysis

The following table captures the details of the analysts’ base case scenario:

Orderly liquidation scenario

Sears’ weak financial position

The Evercore analysts point out that before 2010, the retailer’s reported FCF was positive, albeit weak. The analysts believe that reported FCF on the rapidly shrinking retailer is over-represented as most of the FCF comes from significant under-investment in maintaining the store base.

FCF generated by underinvestment

The analysts note that Sears is in a poor financial position and needs the $2 billion infusion of cash from the REIT conversion to stay afloat:

Sears' deteriorating cash flow

Touching upon the retailer’s productivity, the Evercore analysts note that a long bleed of customers and failure to reset the store base to better locations have left EBIT margins and sales productivity among the lowest in retail:

Weak productivity

Melich and team notes that Sears cash burn trajectory will likely require additional capital in 2015. They point out that their theoretical SOP could fetch only $8 with plenty of risk to the downside as long as operational FCF is negative. The Evercore analysts also say that without some stabilization in sales and material inflection in the rate of FCF burn, the retailer’s asset monetization remains the only path to offsetting current operating losses.