Fairholme Fund (Trades, Portfolio), which renowned investor Bruce Berkowitz (Trades, Portfolio) manages, has accumulated a stake in Sears Canada (SRSC, Financial) from the partial spin-off of Sears Holdings  (SHLD, Financial). Sears Holdings continues to off-load valuable non-core assets through spin-offs and asset sales.
The new stake reported November 6 in a 13G filing reflects a new position of 11,855,328 shares, worth ~11% of the company.
Sears Canada is a multi-channel retailer. It has more than 196 corporate stores, 285 Hometown Dealer stores, 30 home improvement showrooms, over 1,700 catalog merchandise pick-up locations, 108 Sears Travel offices and a nationwide home maintenance, repair, and installation network.
The company’s shares are down 29.94% over the past 12 months and closed at $10.98 per share on Thursday, near a 10-year low (based on Toronto exchange prices).
For its most recent fiscal second quarter, Sears Canada reported revenue of $774 million, compared to $922 million in the same quarter a year ago. Net earnings were -$19 million (or $-0.19 per share diluted) compared to $147 million (or $1.44 per diluted share same quarter previous year) per diluted share in the same periods.
The softness was driven by an unseasonably cool spring. They also took considerable markdowns in aged inventory and surplus seasonal merchandise. CEO Doug Campbell (who has since been replaced), expects to improve on the Sears value proposition presented in store and online at sears.ca. He believes that their offerings in the back-to-school period demonstrates their commitment to customer quality.
Sear’s Canada’s 5-year revenue and earnings history
Sears Canada didn’t purchase any shares during fiscal 2013. But they have proven to be shareholder friendly from previous share repurchases and well as their generous dividend policy (divi yield of 5% for shares on Toronto exchange).
Cash on Sears Canada’s balance sheet totaled $234 million as of the second quarter.
Current perception
In ascertaining the current perception of the Sears Canada’s stock, we use Reverse Discounted Cash Flow to help us see how the market is currently evaluating and pricing a stock presently.
Here are the general calculations we use: current earning per share of $1.99, 10 years of growth at the current growth rate, terminal growth rate of 3% and a discount rate of 12%.
With these calculations we can see that the market believes Sears Canada will lose earnings at a rate of -7.86% a year over the next 10 years.
Current reality
Here is a table of growth rates over the last 1, 5, 10 year periods. This allows us to compare what the market is pricing in today and into the future versus historical growth rates.
Comparing the market pricing in -7.86% versus past growth rates you can start to ask yourself if that current growth rate is likely for Sears Canada in the future?
When you start to compare the numbers you can understand the market's pessimism.
But of course the investor of today doesn’t profit from yesterday’s growth (or lack thereof).
What will be the catalysts to help stabilize the business and increase share price over the long-run?
Is management able to return the business to growth in revenue and profitability?
Will Sears Canada be able to exceed expectations from the market pricing in -7.86% in earnings a year over the next 10 years?
These are the types of difficult questions that must be answered in considering whether there is potential opportunity for investment in Sears Canada.
Conclusion
By many traditional measures Sears Canada seems to be undervalued.
While we give slightly less weight to the technical picture, we glance at the charts from time-to-time because we use more of a hybrid approach to value investing. We have not seen the type of big volume capitulation type move that we like to see in struggling businesses. And this stock does show signs of a steady trend to the downside since topping in late September.
Sears Canada is currently trading at a P/E of 4.80 and P/TBV of 1.19.
So what we have here is a business which seems to be fairly-to-slightly undervalued using traditional metrics with the market pricing in continued trouble ahead.
Sears Canada is interesting mainly because of the recent spin-off, and it being widely under-followed right now. That alone could prove to be a catalyst for this stock to the upside.
But the question still remains: “Does Sears Canada make it out of this retail malaise?”
Positions: None
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