Sears Enters Death Spiral: Vendors Halt Shipments, Insurers Bail

When we commented yesterday morning on the unexpected "going concern" notice in Sears' just filed 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."

As it turned out, we wouldn't have long to wait, because overnight Reuters reported that the worst case Sears scenario we envisioned for Sears is now taking shape and that suppliers to Sears have told Reuters they are doubling down on 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 company's disclosure turned the focus to its vendors as tension is expected to mount ahead of the key fourth-quarter selling season amid rising concern about a potential bankruptcy, they said. 

Quoted by Reuters, 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."

Another supplier to Sears, Arnold Kamler, CEO of New Jersey-based bicycle manufacturer and importer Kent International Inc, said he was not surprised by Sears' Tuesday announcement. He said he noticed a warning sign last year when Sears pushed to increase its purchases, which occurred "because a lot of their current suppliers were either cutting them off or limited them on credit." 

Kamler said he declined to sell Sears more product and that he receives a report once a week from his accounting department because of concerns around billing, payments and deductions. 

The Bangladesh-based clothing supplier said Sears' announcement is making him re-evaluate accepting new orders.

"So far there was only speculation that they would declare bankruptcy in 2017. But now they are acknowledging it, which definitely complicates our relationship with them and our decision to accept future orders from Sears," the executive said.

A second clothing supplier from Bangladesh who did not wish to be named said he renegotiated payment terms with Sears a year ago and was being paid within 15 days of sending a shipment, compared with the traditional 60 days. He is considering asking the company for an advance payment on orders going forward.

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Sears disagreed, and according to Jason Hollar, the company's CFO, Sears' move to raise capital in recent months is helping strengthen the company's balance sheet he claimed in a blog post. 

Sears is "a viable business that can meet its financial and other obligations for the foreseeable future," Hollar said. He cited a $1 billion increase in liquidity from a new secured loan facility and a new asset-based loan that provided $250 million more in "financial flexibility." The only problem with this is that Sears continues to be a melting ice cube which while not as bad as Tesla, is burning through hundreds of millions each year, money which in recent years has come out of Eddie Lampert's pocket, either directly or indirectly, with loan gurantees. At some point even Lampert will realize that throwing away billions to sustain the Sears zombie is no longer a viable strategy, especially if the vendor freak out prompts a sudden need for cash which the company does not have. 

Speaking of Sears' cash, here are some more details from Reuters:

Sears' cash position has shrunk dramatically in recent years. Sears, which lost $2.22 billion in the year ended Jan. 28, 2017, had $286 million in cash on hand, down from $609 million in 2012. Retailers in distress often use their accounts receivable to finance operations, and Sears had $466 million in receivables, down from $635 million in 2012.

So is a bankrtupcy inevitable? Well, yes, and increasingly so with every passing day that the company avoids filing. 

Neil Saunders, managing director at retail research firm GlobalData, said tension will grow as the year goes on. "As we move towards the last quarter, I think we'll find there are more and more suppliers that are not necessarily willing to engage with Sears" and will demand cash up-front. 

Another sign of Sears' weakness is that insurance companies that once provided policies to Sears vendors - insuring against nonpayment for their goods - are no longer doing so.

Doug Collins, regional director for risk services at Atradius Trade Credit Insurance, said his firm has stopped providing insurance to Sears vendors. "We tried to hang in as long as we could," he said. "Vendors may try to get a few more cycles in before the worst happens, and then it just depends if they're lucky or not."

Of course, if that's the case, then Sears has nothing to worry about: if the past 9 years of trading this "market" has shown, is that luck - or hope - is the only strategy that matters for this market, and courtesy of central banks, it always somehow shows up in the last moment. 

Credit to Zero Hedge