I have been asked by numerous media outlets for my comments about the failure of Sears Canada and, in particular, about the dividends paid in the past and their impact on the pension plan. While I take no issue with the decisions that the board of Sears Canada made with regard to dividends and certain real estate sales, I have to emphasize that I have never served as a director or officer of Sears Canada, so I don’t have firsthand knowledge of their internal deliberations and the alternatives considered. I would also note that the dividends paid in 2012 and 2013 represented roughly 50% of the proceeds Sears Canada received from the sale of assets in those years and that the company retained over C$500 million in cash after the dividend payments, with virtually no funded debt. This substantial amount of cash was available to be used in the company’s operations going forward.
While this knowledge cannot change the impact that the failure of Sears Canada has had on many people, particularly its employees, I believe these facts should at least be properly understood given the distorted narrative featured in the media to date. Further context on these topics is available below for those interested in the complete picture, which has been largely ignored despite the time and opportunity to present fair and balanced coverage.
Sears Canada’s Failure
To start, the timing of the failure of Sears Canada was primarily the result of a change in strategy that proved unsuccessful. As outlined in my prior post, I believe that for many years Sears Canada had the resources and the opportunity to transform its business in the face of the pressures on all brick and mortar retailers resulting from the movement of consumers to online shopping. However, in 2016, the company made certain strategic decisions that proved unwise, including pursuing a more aggressive operating strategy to drive sales growth, which consumed cash and required incurring new borrowings in early 2017 for the first time in over a decade. I raised concerns about this strategy with management, but the company decided to proceed with these actions. Ultimately, the deterioration in Sears Canada’s operating performance accelerated and the Board made the decision to file for protection under the CCAA, a decision which ESL was not consulted about and did not agree with. Like many other stakeholders, ESL suffered significant losses from the company’s bankruptcy filing.
Sears Canada was not alone. In a rapidly changing retail industry, individual companies have pursued a variety of approaches to adapt. For example, in 2011 Hudson’s Bay made the decision to close all of its Zellers stores and sell most of its leases to Target for over C$1.825 billion. Target began operating stores in Canada in 2013 and ultimately lost US$5.7 billion when it closed its operations less than two years later.
2012 & 2013 Dividends
In 2012 and 2013, Sears Canada engaged in certain real estate transactions that generated substantial cash proceeds, specifically C$213 million in 2012 and C$906 million in 2013. While the sale of some of these stores enabled Nordstrom’s to begin operating in Canada several years later, Sears Canada retained most of its stores and jobs and attempted to improve its operations – unlike Zellers. which was completely liquidated and Target which abandoned Canada altogether.
With over C$1 billion in cash as a result of these sales, and virtually no funded debt, the Sears Canada Board of Directors decided to make distributions to shareholders in the amount of approximately one-half of those sale proceeds, or C$102 million and C$509 million, in 2012 and 2013 respectively. These dividend payments did not deprive the company of the cash needed to fund operations or to pay pension obligations – quite to the contrary:
• The company retained C$239 million in cash after the 2012 dividend, and C$514 million after the 2013 payment. Further, although there continued to be substantial cash on the balance sheet, and there was virtually no funded debt, no dividends were paid to shareholders after December 2013.
• Sears Canada’s capital expenditures did not decrease due to the dividends. The company continued to invest in its operations at approximately the same level of C$50-100 million annually between 2005 and 2015. In fact, capital expenditures in 2012 and 2013 (C$102 million and C$71 million, respectively) were among the highest since 2005 and it was only in 2016 that they were at a level (C$27 million) below the range of the prior decade.
• Similarly, the payments had no impact whatsoever on the Sears Canada pension plans. Between 2012 and 2016, the company’s benefit plans paid over C$882 million to beneficiaries – including C$167 million in 2012 and C$141 million in 2013. In that same period, the company made all of its required pension plan contributions, totaling an additional C$123 million in cash – including C$34 million in 2012 and C$44 million in 2013. The Financial Services Commission of Ontario, the regulatory agency for pensions in Ontario, confirmed recently in a statement from its spokesperson that Sears Canada “was complying with the pension plan funding requirements under the Pension Benefits Act before the company entered CCAA protection.”
Pension Plan Funding
At the end of 2016, the Sears Canada pension plans had over C$1 billion in assets, and the frequently-cited deficit figure of C$266.8 million is misleading. First, this figure conflates two different obligations – the defined benefit retirement plan, and an unfunded, nonregistered “other benefits plan,” which the company describes as covering health, dental and life insurance, not retirement benefits, and which apparently has not been a funded plan since 2008. Taking the retirement plan alone, as of 2016, the deficit was recorded as C$110 million. And this reported deficit was calculated based on an interest rate assumption that is outdated given the significant increase in Canadian interest rates over the past year. Assuming a reasonable rate of return on its C$1 billion in assets and accounting for the increase in interest rates, Sears Canada should be able to meet its pension obligations.
While I cannot speak for Sears Canada’s Board or management – as already mentioned, I have never served as a director or an officer of the company, nor did I have control over its capital allocation decisions – it is important to understand that an inability to provide adequate returns to shareholders ultimately impacts a company’s ability to maintain its operations and preserve jobs. Many companies in Canada have had to balance providing competitive returns to shareholders, investing in their business and addressing their pension obligations. In fact, some of Canada’s largest companies – Hudson’s Bay, BCE, Rogers Communications, Thomson Reuters and many others which have deficits in their pension plans – continue to both pay dividends and contribute to their pension plans each year.
I too very much regret the failure of Sears Canada. Like all other stakeholders, ESL has suffered significant losses from the bankruptcy of this storied company – shareholders collectively lost over C$1 billion since 2012, even taking into account the dividends received. It is only by ignoring the entirety of the facts that one can conclude that the failure of the company was precipitated by a lack of financial resources rather than an unsuccessful attempt to turn the company around in the face of a rapidly changing retail environment.