I have to admit, I haven’t really been following Eddie Lampert and Sears Holdings closely this year. But when I saw that it had hit $60 today I had to stop and rub my eyes. What exactly happened in the last 3 months to warrant a 50% haircut on the stock price ?
Not much I would imagine, just Mr. Market doing what he does. Excited one month. Depressed the next. It would likely be a good time to take a look and see if the share price is getting into value territory.
Current Market Cap - $7 billion
Cash flow from operations – 2009 $1.5 billion, 2008 $990mil, 2007 $1.5 billion
Capex – 2009 $360mil, 2008 $500mil, 2007 $570mil
So you are looking at an annual cash flow yield of something like $1.3 billion (average of last 3 years) less $500mil capex = $800mil
$800mil/$7billion = 11.4% which is somewhat interesting
Current assets basically equals current liabilities plus debt and pension obligations, so using market capitalization is fairly reasonable in this calculation
What really intrigues me though is that Mr. Lampert keeps buying back shares at a rapid clip. This is where the bulk of his net worth now lies, and I think it would be just silly to assume that he hasn’t thought long and hard about doing this.
And from what I have read the theory is that Eddie views Sears as a collection of various assets. Those assets being the various brands (Diehard, Lands End, Craftsman etc), Sears Canada, Sears Home Services, Sears Mexico, and the real estate. The actual core retail operations are not key to the long term value here and are more or less in run-off until such time as the real estate being used in them can be monetized at desirable prices.
I’m not going to try and get into the valuation of the real estate and the brands today. I think the important thing to realize is that what you have here is situation where you can buy this business at a very reasonable cash flow multiple which protects your downside and have the upside option that Eddie Lampert actually has a plan to unlock the value of the real estate which is currently not earning much for shareholders.
Below are some comments from Bruce Berkowitz of Fairholme who has a large portion of his fund in Sears Holdings:
]“Is deflation – particularly with respect to asset prices – eroding the margin of safety at Sears Holdings?
Deflation eroded the margin of safety, in that real estate values came down as the housing market was destroyed. There is a significant correlation between the housing market and Sears. The answer is yes.
On the other hand, Eddie Lampert was quite astute in the way he handled capital allocation in the last couple of years. In hindsight, you can say it was a mistake for him to buy stock at $150 to $170 – it was a different environment. But by creating a company such that there is significant free cash flow being generated, the company has a huge number of degrees of freedom. If deflation was causing a decline in value and Sears’ shareholders overreacted or very smart people start shorting the stock, then the company has more than enough cash to buy all the shares that Lampert and I don’t own – and together we own over 60% of the company.
It was a real win-win situation, in that I believe it was a temporary condition, but he configured the company for adversity. If you count how much cash he generated in the last few years you will see it. Sometimes it is a little hidden, for example because he had to fill a gap in a pension fund liability because the market turned south and the rules required him to put more money in. He’s also paid off a nice chunk of debt. The company does not have a lot of debt. He has bought back a ton of shares.
If you add up all the money used to do that, it’s a significant amount of free cash”
And from an interview with Bloomberg:
“BRENNAN: - which is run essentially by Eddie Lampert, the hedge fund managers, is assumed to have a so-called "Eddie premium," that because he's associated with managing it that that's what's helping to bolster the stock price because sales haven't been stellar. They may have bottomed out recently, but they haven't been strong so what makes you confident in Sears?
BERKOWITZ: Well, when we look at investments we try and turn the question around and figure out how we could possibly get hurt with an investment as opposed to how much we're going to make.
And when you take a look at the real estate, the brands, the services, the balance sheet, when you look at how much cash the company has generated during a very difficult time for Sears, which is related to the housing market, they've done quite well. Better than most people think, and with an upturn in the economy Sears should follow.
BRENNAN: So it's not a bet on the upside to sales. It's how best they could manage any kind of downturn there with the cash they've got on hand? Is that what you're saying and does this apply to some of your other picks?
BERKOWITZ: Right. What I'm saying is right now you're getting Eddie Lampert's future for free. “
I think that what Berkowitz mentions is important when valuing this company. Sears has been heavily impacted by the housing collapse, so this valuation work might be using very depressed cash flow information.
Not much I would imagine, just Mr. Market doing what he does. Excited one month. Depressed the next. It would likely be a good time to take a look and see if the share price is getting into value territory.
Current Market Cap - $7 billion
Cash flow from operations – 2009 $1.5 billion, 2008 $990mil, 2007 $1.5 billion
Capex – 2009 $360mil, 2008 $500mil, 2007 $570mil
So you are looking at an annual cash flow yield of something like $1.3 billion (average of last 3 years) less $500mil capex = $800mil
$800mil/$7billion = 11.4% which is somewhat interesting
Current assets basically equals current liabilities plus debt and pension obligations, so using market capitalization is fairly reasonable in this calculation
What really intrigues me though is that Mr. Lampert keeps buying back shares at a rapid clip. This is where the bulk of his net worth now lies, and I think it would be just silly to assume that he hasn’t thought long and hard about doing this.
And from what I have read the theory is that Eddie views Sears as a collection of various assets. Those assets being the various brands (Diehard, Lands End, Craftsman etc), Sears Canada, Sears Home Services, Sears Mexico, and the real estate. The actual core retail operations are not key to the long term value here and are more or less in run-off until such time as the real estate being used in them can be monetized at desirable prices.
I’m not going to try and get into the valuation of the real estate and the brands today. I think the important thing to realize is that what you have here is situation where you can buy this business at a very reasonable cash flow multiple which protects your downside and have the upside option that Eddie Lampert actually has a plan to unlock the value of the real estate which is currently not earning much for shareholders.
Below are some comments from Bruce Berkowitz of Fairholme who has a large portion of his fund in Sears Holdings:
]“Is deflation – particularly with respect to asset prices – eroding the margin of safety at Sears Holdings?
Deflation eroded the margin of safety, in that real estate values came down as the housing market was destroyed. There is a significant correlation between the housing market and Sears. The answer is yes.
On the other hand, Eddie Lampert was quite astute in the way he handled capital allocation in the last couple of years. In hindsight, you can say it was a mistake for him to buy stock at $150 to $170 – it was a different environment. But by creating a company such that there is significant free cash flow being generated, the company has a huge number of degrees of freedom. If deflation was causing a decline in value and Sears’ shareholders overreacted or very smart people start shorting the stock, then the company has more than enough cash to buy all the shares that Lampert and I don’t own – and together we own over 60% of the company.
It was a real win-win situation, in that I believe it was a temporary condition, but he configured the company for adversity. If you count how much cash he generated in the last few years you will see it. Sometimes it is a little hidden, for example because he had to fill a gap in a pension fund liability because the market turned south and the rules required him to put more money in. He’s also paid off a nice chunk of debt. The company does not have a lot of debt. He has bought back a ton of shares.
If you add up all the money used to do that, it’s a significant amount of free cash”
And from an interview with Bloomberg:
“BRENNAN: - which is run essentially by Eddie Lampert, the hedge fund managers, is assumed to have a so-called "Eddie premium," that because he's associated with managing it that that's what's helping to bolster the stock price because sales haven't been stellar. They may have bottomed out recently, but they haven't been strong so what makes you confident in Sears?
BERKOWITZ: Well, when we look at investments we try and turn the question around and figure out how we could possibly get hurt with an investment as opposed to how much we're going to make.
And when you take a look at the real estate, the brands, the services, the balance sheet, when you look at how much cash the company has generated during a very difficult time for Sears, which is related to the housing market, they've done quite well. Better than most people think, and with an upturn in the economy Sears should follow.
BRENNAN: So it's not a bet on the upside to sales. It's how best they could manage any kind of downturn there with the cash they've got on hand? Is that what you're saying and does this apply to some of your other picks?
BERKOWITZ: Right. What I'm saying is right now you're getting Eddie Lampert's future for free. “
I think that what Berkowitz mentions is important when valuing this company. Sears has been heavily impacted by the housing collapse, so this valuation work might be using very depressed cash flow information.
