Sears Death Spiral Accelerates: Vendors Halt Shipments As Cost Of Default Insurance Soars

When we commented back in March on the unexpected "going concern" notice in Sears' 10-K which sent the stock crashing, we pointed out the immediate spin provided by Eddie Lampert's distressed retailer which promised that its comeback plan may help alleviate the concerns, “satisfying our estimated liquidity needs 12 months from the issuance of the financial statements", to which however we added the footnote that "the question is what happens when vendors start demanding cash on delivery as concerns about SHLD.'s liquidity concerns continue to grow."

Shortly after, we wrote "Sears Enters Death Spiral: Vendors Halt Shipments, Insurers Bail" in which we described that as Sears financial condition deteriorated, vendors were boosting their "defensive measures", such as reducing shipments and asking for better payment terms, to protect against the risk of nonpayment as the company warned about its finances.

The managing director of a Bangladesh-based textile firm said his company is using only a handful of its production lines to manufacture products for Sears' 2017 holiday sales. Last year, nearly half of the company's lines in its four factories were producing for Sears. "We have to protect ourselves from the risk of nonpayment," said the managing director, who declined to be identified for fear of disrupting his company's relationship with Sears.

 

Furthermore, precisely as we predicted, Mark Cohen, the former CEO of Sears Canada and director of retail studies at Columbia Business School said vendors will keep a close eye on Sears' finances. "Whatever vendors continue to support them are now going to put them on even more of a short string. That means they’ll ship them smaller quantities and demand payment either in advance or immediately upon delivery."

 

He added: "Sears stores are pathetically badly inventoried today and they will become worse."

Fast forward five month when just after Sears reported another quarter of painfully bad results including an unexpected double-digit drop in same store sales, Reuters writes that the "worst case" scenario we envisioned for Sears is now accelerating, and that Sears is having trouble stocking shelves, "as some vendors have fled while others are demanding stricter payment terms because of difficulties hedging against default risk."

One reason why Sears' supply chain is in greater turmoil than ever - in addition to Sears' woeful financials of course - is due to the scarcity and high cost of a type of vendor insurance known as accounts receivable puts, which ensure a supplier will be paid even if the retailer files for bankruptcy. Think of them as CDS contracts vendors can buy on a counterparty, in this case their (increasingly insolvent) client, and just like CDS, the puts become prohibitively expensive the closer the underlying entity is to bankruptcy.

“It’s too expensive,” Michael Fellner, owner of Montreal-based women’s wear company Lori Michaels Apparel & Manufacturing Inc, told Reuters about the specialized vendor insurance. He also said he stopped shipping to Sears in March, when his insurer stopped providing coverage.

Two other small vendors told Reuters they stopped supplying Sears this year because they could not afford the insurance, whose cost spiked after Sears warned in March of “substantial doubt” over its ability to continue as a going concern. They asked not to be identified discussing confidential commercial arrangements.

Most concerning, however, is the discovery that Eddie Lampert himself appears to be throwing in the towel on the supply chain: as Reuters explains, Sears’ vendors had previously benefited from support from Sears CEO, billionaire Eddie Lampert, who owns almost half of the company’s shares and is also its largest lender.

Through his hedge fund, ESL Investments, Lampert invested in vendor insurance contracts worth $93.3 million in 2012, $234 million in 2013 and $80 million in 2014, according to SEC filings. Lampert's implicit support of vendors however ended one year ago: filings show no investment by Lampert in vendor insurance contracts since 2015.

A Sears spokesman said the 55-year-old billionaire is not currently investing in these contracts and declined to say why.

In addition to Sears' top stakeholder dropping support, for whatever reason, other hedge funds such as Avenue Capital Group, and traditional credit insurance firms such as Euler Hermes Group, have also exited the insurance market, brokers and investors said. They did not specify the timing of their withdrawal.

Predictably, as the number of market participants in the receivables puts market collapse, the cost of insurance contracts surged as they became harder to come by, putting pressure on Sears’ ability to maintain a robust inventory of goods. As a result, merchandise inventory at Sears fell to $3.4 billion as of July 29 from $4.7 billion a year ago, the company disclosed on Thursday. Sears has attributed the inventory decline to its transformation to an online-oriented business from bricks-and-mortar stores.

“We continue to work to manage our vendor relationships in a constructive manner… we will continue to ensure that our vendors deliver on their obligations to Sears,” Sears said in its second-quarter earnings statement on Thursday. The reality is that it simply does not have as many suppliers as it once did.

Meanwhile, those who can find puts to buy are simply unable to afford them: brokers and investors said that Sears insurance contracts for vendors are currently quoted at more than 4 percent of the value of the vendor’s shipment per month, making them uneconomical for many suppliers whose profit margins are in the single digits. Three years ago, the contracts were being quoted at about 3 percent per month.

LG Electronics Inc, which makes Kenmore-branded washing machines and refrigerators as well as LG-branded appliances, told Reuters it has not bought vendor insurance in the past year because of the cost.

 

Instead, LG said it negotiated shorter payment schedules to minimize the risk of not being paid by Sears. It declined to say how short the payment period was. The typical payment schedule in the industry is close to 90 days, though it can vary by item.

Of course, the shorter the payment terms, the bigger the hit to Sears' working capital and, thus, liquidity, with the most dire option being cash on delivery in which vendors simply will not provide the much needed inventory unless they are paid on the spot. Here's Reuters:

Sears has promised to pay some suppliers within 15 days, according to a source familiar with the matter who requested anonymity to discuss confidential commercial arrangements. Sears declined to comment.

 

A 15-day payment schedule gives a vendor priority for repayment in the event of a bankruptcy. This is because claims received within 20 days of a bankruptcy filing are typically repaid in full.

 

Some vendors are so keen for this protection, that they have offered Sears a small discount of around 5 percent on their merchandise, the source said.

As noted above, the increasingly shorter terms means a sharp erosion in working capital: William Danner, president of CreditRiskMonitor.com told Reuters that at the end of the second quarter, Sears would likely have used $587 million to boost working capital – mostly from asset sales – due to the decision by some vendors to not extend as much credit. Sears’ available liquidity at the end of July was $810 million.

“Even for a huge company like Sears, finding this much more capital is a burden. This apparent loss of confidence in Sears by its vendors is greater now than it was at the end of 2016,” he said. Should more vendors demand the same payment terms, there is a risk that Sears entire liquidity cushion could disappear.

Eddie Lampert, who has valiantly fought for years to delay Sears' inevitable bankruptcy, has complained on several occasions that vendors are trying to exploit Sears’ woes to negotiate better terms. He said last month that some of its vendors reduced their support, “thereby placing additional pressure” on Sears.

Sears took the issue to court in June, when it sued Ideal Industries Inc after the maker of Craftsman-branded tools declined to fulfill purchase orders because of Sears' "known fragile financial condition," according to court documents. Ideal Industries declined to comment.

And while Lampert may no longer be funding vendor insurance, he is still supporting Sears in more "brute force." He held about $1.7 billion in debt mainly backed by the company's real estate and inventory as of April 29, according to regulatory filings.  The reason for this shift is that unlike secured debt, vendor insurance contracts are not backed by any collateral. Underscoring his "support", last month, Lampert extended a $200 million 151-day credit line to Sears at an annual interest rate of 9.75 percent.

To be sure, not everyone has thrown in the towel on Sears: at least one investment firm, Blackstone Group LP's distressed credit arm GSO Capital Partners is backing Sears contracts through December although they did not disclose their value to Reuters.

However, it's only a matter of time - in this case a few more quarters of declining same store sales - before virtually everyone gives up on Sears, forcing Lampert to decide between directly funding the company's inventory or finally admitting defeat to the Jeff Bezos juggernaut, and pulling the plug.

Comments

sunkeye Aug 25, 2017 5:46 PM Permalink

If Sears dying out ain't a sign America is too, I'd like to know wtf is.Reagan saved Harleys, Carter bailed out Chrysler, MAGAman should step in & do the same F'n thing for this American instititution.

surf@jm Aug 25, 2017 4:41 PM Permalink

Lol!.....Big Wow.....How many years now, has J.C. Penney had negative earnings, but still has its doors open?.......FED easy money zombies rule........

OccamsCrazor Aug 25, 2017 2:23 PM Permalink

Anyone with ANY money simply shops at specialty stores, and usually name brand. People with no money, or barely any money, shop at Walmart, Dollar Store, Aldi's, and Kohl's.  If its a commodity like Tires that are once every 4 or 5 years, people go to tire stores like Discount Tire.  For home renovation, including appliances, it's Home Depot or Lowe's. Sears and Pennies all have outdated identities that did not change with its competition, and in fact allowed specific niches of competitions to do each individual category of goods, far better than Sears or Pennies who tried the 'let's do everything approach' that died like malls have since the 90's. Amazon then put the nail in the coffin for them, by doing nearly every category cheaper and with free shipping, which eliminated any trips to brick and mortars.  That was the killer.  It took people out of the malls and out of stores, unless they absolutely had to physically see the item and touch it before buying. So every single type of competitor and every category of goods provider became competition to Sears (and Pennies) and stole away their entire customer base.  They only survive on the people still alive who remember Sears for the old days.  Hence that population is declining as is their purchasing power (think old people on SS), Sears sales continues to decline.  They are not attracting any new customer base.  They don't give people a reason to shop there. Their on-line presence, is just a list of other 3rd party vendors, who market on their web-site.  So its a REALLY weak dupe of Amazon.  Lampert doesn't give a crap about being a retailer.  He doesn't know what it means to be one. He's a VC, (vulture capitalist) who essentially preyed on naive shareholders, and employees of Sears.  He's also likely a sociopath who simply derives pleasure from seeing the demise of others, while he maintains total power.  His wealth can fluctuate, but barely be harmed.  Worse case is he eventually sells off property worth more than the store revenues.  Until then, its a great tax write off for him.  

Stan Smith Aug 25, 2017 2:22 PM Permalink

    I think the last time I stepped into a Sears was to help my father buy a lawn mower sometime in the late 90s.    I'd argue Sears (and Kmart for that matter) are two companies (now one) that has done less to adapt to reality than almost any other retailer.    Considering their fate was essentially telegraphed the day those phone book sized catalogs started becoming useless and they did little or nothing to adapt to what was happening -- and still do this today.    Other than Craftsman tools, they have no brands that make anyone want to shop there over anywhere else.   And at this point there's plenty of alternatives for those tools as well.    Im amazed they are still around to be honest.   

GunnerySgtHartman Aug 25, 2017 1:45 PM Permalink

Eddie Lampert, who has valiantly fought for years to delay Sears' inevitable bankruptcyEddie Lampert is a large part of the problem.  He knows very little about retail, focusing on retaining existing customers rather than trying to woo new customers and not working on increasing transaction size, preferring his "Shop Your Way" loyalty program which cuts into already-thin retail profits.  He's burning the furniture to keep the house warm (selling off iconic brands).  He has ignored one of Sears' (former) strengths, in-home repair service, because it isn't sexy (never mind it is very profitable).  He's also a dictator, firing anyone who disagrees with him; his turnover of executives has been astounding.  Under Lampert, Sears has been holding the world's-longest liquidation sale.That's not to say Sears was problem-free before he gobbled up Sears - as others have said on here, Sears was too attached to the mall brick-and-mortar model as well as being very late to the game with online shopping.He's going to take Sears down and good people with it.  He's essentially protected himself, though, having hedged his bets through his ESL Holdings fund - and he may actually make money if Sears goes BK because he's secured his bet through Sears' real-estate holdings, among other things.The fish rots from the head down.

adr Aug 25, 2017 1:21 PM Permalink

When Sports Authority went bankrupt we were owed almost $2 million, the insurance policy paid $1.2 million but still left us with a $800k loss, which is still a huge cash flow problem for a small business. It also took almost a year for the insurance payment to be made. When you base your business on 90 day payment terms, not getting paid for 12 months at a loss isnt good. At least we didn't borrow on accounts receivable like other companies. That is what put EVO Shield out. It is pretty hard to pay back a loan on money you are supposed to receive if you never actually get it. That is why I know Amazon is a total con job. It isn't possible to be cash flow positive based on their business tactics. 

Robert Trip Aug 25, 2017 12:56 PM Permalink

Greed did them in.The shoe department had no sales person right after a big shoe sale was announced.I tried on a few pairs and was waiting for someone to show up so I could pay.The poor woman who finally appeared apologized stating she was alone to man 3 different departments.Pretty fucking sad and now the assholes are paying the piper.By the way, Sears in Canada is facing a heavy duty lawsuit for rewarding their upper management with huge bonuses in order for them to stick around to right a sinking ship, the very ship they were responsible for sinking, while completely screwing their hourly employees out of any severance payment.

mrjinx007 Aug 25, 2017 12:52 PM Permalink

I can't rember how may times the glofied Harbor Freight company has gone bankrupped and come back again.  I laughed when I saw the stock hit $170 a share.  What a joke.

cynicalskeptic Aug 25, 2017 12:47 PM Permalink

So..... suppliers cannot buy insurance that will pay them if a retailer buying their goods goes bankrupt because the risk is too high.    This is a case where the buyer of the insurance has a clear risk in supplying goods and a vestesd interest in the transaction.  Yet the insurer won't write the policy because they're worried about the buyer going out of business.  YET we had (still have) financial institutions writing credit default swaps for firms making a pure bet on financial instruments - they do NOT own any of the instruments tehy are seeking 'insurance' for (in fact they may have sold the instruments knowingg full well that they are garbage and will fail).  The writer of the CDS doens't seem to care if the policy is a horribly bad one on an instrument that is pure crap because the government will bail them out if all goes to hell (remember AIG and Goldman Sachs?)Just another way in which Wall Street gets aaway wit fraud and makes trillions while Main Street goes down the crapper.

Jean-Luc Picard Aug 25, 2017 12:40 PM Permalink

Sears deserves it. The quality of customer service has been horrible for years, while the stores are ugly and outdated. Merchandise is scattered around in no particular fashion.

Rex Andrus Aug 25, 2017 12:37 PM Permalink

Sears in name only. They zombied long ago, when nothing on their shelves or in their catalog was Made in America, when they renegged on the Craftsman lifetime warantee. Get some holy water to burn the financial maggots off the corpse and bury it.

Maximeme Q Aug 25, 2017 12:11 PM Permalink

Several years ago I read an article about the shitty management at Sears at the corporate level and at individual stores. It may have been here on ZH but I'm thinking it was somewhere else. The author personally visited a handful of stores within an hour's drive and included pictures to back up his assertions. It was both pathetic and funny. Empty or poorly stocked displays, entire departments where about 30% of the flourescent tubes were either burned out or turned off and it went on and on. The one pic that really stayed with me was the teevee displays. They had this really tacky and dirty 4'x6' football field rug the middle of an aisle that made absolutely no sense. You'd have to see the pictures for context but I could smell BK then and this was well before Sears really started to hit the skids.I wish I could find it now. A perfect companion to this death spiral piece.

Give Me Some Truth Maximeme Q Aug 25, 2017 12:59 PM Permalink

The story you referenced was clearly written by a contrarian journalist, probably for a non-mainstream media organization. My take-away: The "truth" about the fate of this company was obvious years ago, or should have been. All kinds of similar stories could be written about all kinds of other businesses, especially in retail, today. But they aren't being written. I'm sticking to the hypothesis I shared two days ago - the mainstream media is conspiring to hide the truth about the economy because it doesn't want to panic the masses. The bosses of the corporate media have probably been advised by their peers in other Establishment groups to adopt this posture: "Whatever you do don't report the truth!" You think things are scary now, just go and tell everyone what's really happening.As such, concealing the truth is spun as a noble exercise, something that must be done for the good of the country. I'm sure those rigging the precious metals markets employ the same rationalization/excuse to ease their consciences. 

In reply to by Maximeme Q

homebody Aug 25, 2017 12:22 PM Permalink

Just out of college, I was one of the youngest Department Managers at Sears.  I soon realized that the direction they were going was not what I believed would work in the future and I quit.  Best move i ever made.They had it made with the catalog business that just needed a little expansion and foresight - they could have become Amazon well ahead of the rest of the industry.  Then they failed to build on their strengths  - the hardware and appliance divisions.  Too bad the long term staff members do not get to share in the remaining equity.edit - they called a meeting of all managers in our area, asked what they could do to help the managers be more successful.  When some few spoke up, their opinions were ignored because the upper management were the "smartest men in the room".   They believed in "make it your responsibility but give you no authority to make decisions".   

hanekhw Aug 25, 2017 12:04 PM Permalink

Sears is probably worth more now dead than alive but I don't know the pension liabilities and the warranty liabilities but the real estate must be worth a considerable amount.

Give Me Some Truth hanekhw Aug 25, 2017 12:50 PM Permalink

Aren't most Sears' locations "anchor stores" in malls? That real estate is worth less than zero. I don't know who would buy a mall for $1. You'd have to raze it and haul off all the debris and then figure out how to develop the dirt. Hundreds of cities have discovered that this is pretty much the truth. In our town, a dead mall now is home to a fire station. City government is the only entity that would lease a tiny bit of its space.

In reply to by hanekhw

markar Aug 25, 2017 12:04 PM Permalink

Since Lambert, Sears has been nothing but a hedge fund masquerading as a retailer. Now that he's sucked its last drop of blood, it can die its inevitable death.

Give Me Some Truth markar Aug 25, 2017 1:08 PM Permalink

Re: Put a fork in it.If Sears does come back it will be the Mother of All Comeback Stories. I guess J.C. Penney's is next. This "retail apocalypse" by itself should have been enough to be the triggering event of the great re-set. It's that massive and has that many ripple effects. But the experts and the markets seemingly just "shrug it off."This to me is even more evidence that the entire game is rigged. 

In reply to by markar

CRM114 Aug 25, 2017 12:00 PM Permalink

Just like Target Canada, shit senior management can ruin everything.Perhaps people ought to be hired who are good at their job, rather than good at schmoozing up to their boss and ticking HR's 3 million little boxes?Especially in Sears case, where they took the World's greatest remote sales company into the internet ordering age, and f#cked the whole thing up. Any department manager in a Sears store could have told them what they were doing wrong (I 've spoken to two), but they didn't care to listen.In itself, this has nothing to do with Amazon. Sears should have been Amazon. For 100 years it WAS Amazon.

ali-ali-al-qomfri stormsailor Aug 25, 2017 12:27 PM Permalink

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Kingdom: Capitalus Phylum: Corporatious Order: Retailian Family: Cubus-Grandes Genus: Catalogues-Orderes  Found in fossil samples in the Fukushima Boundry Layers.

In reply to by stormsailor

aliens is here Aug 25, 2017 11:52 AM Permalink

How about get rid of them low class hijab wearing employees and then hire some normal looking friendly helpful ones. You might just see some hope in turning Sears around.

techpriest aliens is here Aug 25, 2017 1:24 PM Permalink

If they did that ten years ago, maybe. Now we're at the point where Sears is associated with "failing store that has no goods and bad service" deep in folks' mind, and it would take a lot more than simple improvements to change that.

If they really wanted to turn the chain around, they would drop the "Sears" brand as it currently is, fire all of the first 2 layers of upper management, and roll out what is effectively a new store concept. However, at this point it would be better to kill the brand, and sell off the buildings to some other company.

IMO the executives are riding out the crash and trying to collect as many paychecks as possible before finally walking away.

In reply to by aliens is here

skinwalker Aug 25, 2017 11:51 AM Permalink

My MIL has been boycotting sears for 40 years after they sold her shoddy appliances.

She's thrilled beyond belief that she's finally winning.

Hopefully in the fullness of time I will do the same over the demise of amazon.