Advertising cuts at Sears seen a risk for company's turnaround

(Reuters) - Sears Holdings Corp's (SHLD.O) strategy to cut advertising and discounting is raising concerns among analysts who question whether the venerable retailer will be able to attract new customers.

Chief Executive Eddie Lampert said Sears has become more efficient by replacing traditional marketing with digital and tailored advertisements, while focusing on members of its loyalty program, Shop Your Way, who account for three-quarters of sales.

But Sears on Monday reported the biggest drop in sales at existing stores in at least a decade for the first-quarter - a combined 10.9 percent between its Sears and KMart stores.

"Most consumers are not aware of positive changes at Sears or Kmart," said Efraim Levy, equity analyst at S&P Capital IQ. "You need to drive traffic. Otherwise you just keep on seeing lower and lower sales in a vicious cycle."

He believes Sears still needs to get significantly more customers to visit its stores to remain a viable retailer. He reiterated his "strong sell" rating on Sears shares after the quarterly results.

Lampert has said he is not necessarily out to attract new customers to the Shop Your Way program and that his focus is on getting existing customers to increase spending at Sears or Kmart at the expense of rivals.

On a comparable basis, Sears cut advertising by $54 million in the first quarter, equal to roughly half of the decrease in its net loss, down to $303 million from $402 million a year earlier. Margins were also boosted by a $40 million drop in expenses related to the allocation of reward points for the loyalty program.

Sears has been criticized for not keeping stores up to date, but executives say a new effort is being put into its private-label apparel, dropping a line by Kim Kardashian, for example, in favor of generally less expensive store brands.

Burt Flickinger, managing director of retail consultancy Strategic Resource Group, said the merchandise looked good.

"For basic fashion and colors it's the best it has been in years," said Flickinger, who is not working for Sears but has been doing research on the category, including at rivals J C Penney (JCP.N) and Kohls (KSS.N).

But potential shoppers need to be told about the improvement, likely via advertising, he added.

"If they can communicate better" there is an opportunity to boost sales, he said.

Sears, whose margins have been weighed down by costs to promote its loyalty program on top of traditional discounts, said cuts in promotional spending helped boost gross margin to 25.8 percent of sales from 23.2 percent.

The shift to rein in promotions shows how price sensitive Sears' core customers are and highlights a key challenge for the company as it tries to turn profitable while aggressively cutting costs, said Gimme Credit debt analyst Evan Mann.

"If they want to be viable long term they need both revenues and margins to improve," Mann said.

(Reporting by Nathan Layne; Editing by Leslie Adler)