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Did Sears Holdings Really Drop From $120 in April to $60 Today ? How did the value of the business change by $ 7 billion ?

August 20, 2010 | About:
CanadianValue

CanadianValue

212 followers
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.

About the author:

CanadianValue
http://valueinvestorcanada.blogspot.com/

Rating: 4.0/5 (20 votes)

Comments

jim.falbe
Jim.falbe - 4 years ago
Great article. We all like Sears, but thank you for alerting is that it has dropped so dramatically in price.
batbeer2
Batbeer2 premium member - 4 years ago
because sales haven't been stellar.

Sales have certainly been stellar... on a per share basis that is.

$ 375 of revenue per share up from $ 300 in 2006. That almost beats WMT for growth.

Just for fun, look op revenue per share of WMT, M, TGT et al.
AlbertaSunwapta
AlbertaSunwapta - 4 years ago
Didn't Buffett remark that the average NYSE stock moves 50% in a typical year? (I believe in a forward to the Intelligent Investor - an early 1980s version) I'll have to try to find that reference.
Sivaram
Sivaram - 4 years ago


Even if the fundamentals didn't change, there is a big flaw in the original thinking. Just because the shares dropped 50% doesn't mean the market is being irrational. How do you know the shares weren't overvalued initially?
CMW
CMW - 4 years ago
$360m in capex for a national retailer. And what was Wal-Mart's capex last year? So what does that tell you about Sears as a going retail concern?

Have you visited Sears in a relatively competitive location sometime in the past year, and noticed how dead the place is? I mean devoid of any customers. Totally and completely dead. Do you know any shoppers that know anything about them, good or bad? Not me and we shop all the thrifty spots, hard.

Whether you think the stock is cheap or not, don't tell me they are fighting to compete with Wal-Mart because that is crazy. Tell me something about their liquidation value because I don't buy the going concern analysis.
superguru
Superguru - 4 years ago
While valuing Sears, its retail operation should be valued at 0.

As a retailer, It is in same category as KMART was. Though Sears has advantage of having a good capital allocator at helm in Eddie. I heard Whitman made good money off his KMART investments... do not know much about it but may be same script can play here.

What Sears has is its brands and real estate and Eddie.

CanadianValue stated it well -

"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. "

batbeer2
Batbeer2 premium member - 4 years ago
don't tell me they are fighting to compete with Wal-Mart because that is crazy

I'm not. I'm just pointing out that on a per share basis, Sears is growing at a similar rate. Lampert chooses not to spend on capex but to buy back shares. It's working. Revenue is in decline but the share count is dropping faster. This can't go on, it will stop.

Invert, would you like a fast growing business that was growing its share count at an even higher rate ? That too, stops.

Assuming the "dead" stores you mention are the ones causing sales to drop, tying up inventory etc..... sell/liquidate/close those stores and then what have you got ? This is not speculation. Lampert has had a policy for years to close/sell every single store that costs more than it earns. You can be sure the "dead" shop you visited is either profitable or closing down.

At some point, we have say $500 of sales per share; I guess 35B gross. That revenue must be coming from somewhere no ? If you close the unprofitable stores, what remains is more vital. If that vitality does not come from high capex, then that revenue comes from spots where there is less competition.

Have you visited Sears in a relatively competitive location sometime in the past year

That is the whole point. Lampert believes there is too much retail space in the US. Also, online stores will continue to take share from brick and mortar retailers in the long run.

In short, spending on brick and mortar stores that are losing money makes no sense today. Strangely, poeple question the wisdom of doing the opposite.
CMW
CMW - 4 years ago
You should read up on brands, because they are not eternal rights to excess free cash margins like some seem to believe. They require a lot of investment. A leading brand is truly awesome in terms of what you can earn from it, but it becomes worthless over time without ongoing support. The no.2, 3, 4, 5 brands are forever spending and trying to knock you off, and they will succeed if you let them. $350m does not seem adequate to support all those brands you mention.

The only asset which has (ie. past does not guarantee future) appreciated over time with no capex is good real estate. The decline of the physical structure has been more than offset by rising land values.

So is that the thesis here - use the current cash flows from good brands to buy back shares and hope it delivers more value than actually investing in them, plus the value of their real estate? Not saying that's a poor thesis at all, just want to know what we're talking about here.
AlbertaSunwapta
AlbertaSunwapta - 4 years ago
I've been using the internet since 1993, so we're approaching nearly the second decade of increasingly proficient internet users accelerating their use of online shopping but I believe that is a trend that will slow and brick and mortar will survive due to their ability to provide shoppers with both socializing, entertainment, tangible goods and immediate gratification and sometimes significantly less hassle than online purchases.

Moreover, the melding of convenient bricks and mortar locations with online shopping may take much of the grief out of product delivery, returns, warranty issues, recalls and other claims. Brick & mortar inventories may also enable speedier and cheaper online shopping and delivery.
AlbertaSunwapta
AlbertaSunwapta - 4 years ago
In fact, I wish Sears had bought out Overstock.com at it's lows but not to meld the two but to utilize each others 'platforms' for some synergies.
batbeer2
Batbeer2 premium member - 4 years ago
use the current cash flows from good brands to buy back shares and hope it delivers more value than actually investing in them, plus the value of their real estate.

Close enough. The current strategy is one of liquidation. If it goes on till there is nothing left, shareholders IMO won't lose a lot of money at current prices.

Having said that, I personally don't think Lampert plans to liquidate the whole company.

Capex.... I do think that is unsustainably low. Let's say Lampert reverses his strategy and starts spending 1B on capex after SHLD has shrunk to 35B of revenue. How many 8B shops out there have a choice of spending 1B on capex annually ?

A shop with 35B of revenue spending roughly 1B on capex.... that's a high end version of Macy's.... seriously ! Lampert choses every day NOT to become Macy's worst nightmare. IMO he's right.

As for brands..... indeed, they are assets; they need maintenance.

My idea of the future is that Lampert will, at some point, start spending 1B annually on the part of Sears that, in his view, does have a bright future. That will become clear only AFTER the shares have risen above what he percieves to be liquidation value.

In short, Lampert is doing exactly what the shareholders of very many marginal companies are telling management to do and investors don't like it.
batbeer2
Batbeer2 premium member - 4 years ago
brick and mortar will survive due to their ability to provide shoppers with both socializing, entertainment, tangible goods and immediate gratification and sometimes significantly less hassle than online purchases.

Yes.
superguru
Superguru - 4 years ago
and most gurus have been selling SHLD at these so called low prices.

Actually Gurufocus shows Eddie Lampert has reduced his SHLD stake.
batbeer2
Batbeer2 premium member - 4 years ago
Actually Gurufocus shows Eddie Lampert has reduced his SHLD stake.

Gurufocus probably tracks the fund and not his personal portfolio. Shares were transferred not sold. In January, his investment vehicles filed three SEC Form 4 filings, detailing an interesting transaction......

ESL Institutional Partners, L.P. (“Institutional”) distributed these shares of common stock, par value $0.01 per share, of Sears Holdings Corporation (“Shares”) to its general partner, RBS Investment Management, L.L.C. (“RBSIM”), in an in-kind pro rata distribution for no consideration. RBSIM then distributed these Shares to its members in an in-kind pro rata distribution for no consideration.

http://www.sec.gov/Archives/edgar/data/860585/000089375010000009/xslF345X03/edgar.xml

It would be more correct to say Lampert has increased his stake.

mevsemt
Mevsemt - 4 years ago


I guess the real question is "why?" Is he doing this with ESL's other holdings as well? If not, why would he only do it with SHLD?

Can the distributed shares be sold w/o having to file with the SEC? Obviously if ESL starts publicly dumping shares the price of SHLD would plummet, so is this a way for Lampert to sell shares quietly?

OR, could this be a situation similar when Buffett wound down his partnership but retained his stake in Berkshire?

Or maybe he's doing it for some other reason, thoughts anyone?

batbeer2
Batbeer2 premium member - 4 years ago
Is he doing this with ESL's other holdings as well? - Yes; all of them.

Or maybe he's doing it for some other reason, thoughts anyone? - taxes http://www.bloomberg.com/news/2010-06-08/lampert-may-avoid-obama-tax-increase-with-864-million-hedge-fund-payout.html

sclarksons
Sclarksons premium member - 3 years ago
Interesting thing about sears and Capex.

Sears minimizes Capex and tries to expense everything.

While Most mgmt tries to load everything onto the balance sheet to maximize reported earnings, Lampert tries to expense everything he can and chooses expenditures that can be expensed over ones that must be capitalized when faced with a choice.

- from conversation at the annual mtg last year.

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