Saturday, February 16, 2008 0 comments ++[ CLICK TO COMMENT ]++

Added to Watch List: Sears Holdings (SHLD)

I don't consider myself as a pure value investor but if one was inclined towards value investing and was to blindly invest in a company, I can't think of too many better candidates than Sears Holdings (SHLD). It's amazing to see so many superstar value investors take a position in Sears (note: the list may have changed since then so we don't know the exact holdings). The list includes Martin Whitman, Jean-Marie Eveilard, Bruce Berkowitz, Mohnish Pabri, and...uh... Bill Ackman. For once, I'm on the same wavelength as Ackman ;)

I don't invest blindly based on others (not only do you not have the same risk profile and investing time horizon, but you will also learn nothing (I'm trying to learn on my own :) )). But Sears is starting to look attractive on its own. If you are looking for something with a lower risk profile and don't ever want to hear the word subprime ever again :) Sears may be worth considering.

Current Numbers

Here is how Sears stacks up right now:

Market cap: $13.6 billion
TTM P/E: 12.2
Forward P/E: 23.8
P/Book: 1.26
P/Sales: 0.26

ROE: 10.9
Debt/Equity: 0.41

The stock is down around 50% in the last year, and is basically trading at the 2005 price. The most attractive thing about SHLD is its low price-to-book-value. It is only trading around 25% above its book value, and if the stock drops closer to book value, it can be highly attractive IMO. You won't find many big-name retailers trading at P/B of around 1.25.

What Went Wrong

Sears stock is getting clobbered--down over 50% in an year--and most of it is attributed to poor management. In fact, Herb Greenberg awarded the worst CEO of 2007 to Eddie Lampert of Sears. I'm not so sure. If you look at its competitors like JC Penney, Macy's, and so forth, all of them have followed a similar pattern. All the retailers are selling off due to a slowing economy. The real test is what happens over the next couple of quarters when the economy actually slows down and the good performers will be seperated from the poor ones.

I haven't been following Sears closely but did pay some attention to it over time. There was, what I feel, a lot of speculation in the stock over the last few years. A lot of it centers on two theories.

The first theory was that Sears has severely undervalued real estate holdings. This is illustrated clearly in this October 2007 Barron's article. According to Bill Ackman's Pershing Square calculations, Sears' enterprise value per square feet is only $33 versus $100 to $600 for competitors. This may very well be true but I don't value it that much due to the potential for a commercial real estate collapse. Commercial real estate may be entering a correction and it will be awefully tough for Sears to unlock that value any time soon. It probably also isn't easy to unload your real estate while other retailers are cutting back due to a looming slowdown in the economy. I think the real estate story has merit but it can take a long time to unlock the value.

The other theory that propelled the stock was when so-called value investors loaded up on SHLD on the expectation that (i) Eddie Lampert will be the next Warren Buffett (BusinessWeek cover may be a curse like the Sports Illustrated cover ;) ), and (ii) Sears' cash flow will end up being used to finance other investments (a la Berkshire Hathaway, the original textile mill, and Buffett's investments in Geico/etc)... Well, I would run away from the first thought. I have a lot of respect for Eddie Lampert (read below) but no one knows who is going to be the next Warren Buffett--assuming there will be a better investor. This is like how everyone thinks the next big superstar in the NBA is the next Michael Jordan. Well, people have been saying that about Jordan for years; and people will be saying the same thing about Buffett for years if not decades... I also wouldn't put much faith on the second strategy panning out well. Eddie Lampert supposedly has other private holding companies so how can you be sure SHLD will be his main vehicle? Furthermore, nothing Eddie Lampert has done indicates to me that he wants to wind down Sears and use the cash flow elsewhere. If anything, he is committed to Sears as a retail operation.

Why Sears is Worth Considering

So, it is not only growth investors who trip over themselves on some hot idea; value investors can be quite speculative as well. I think all the froth related to the points cited above is out of the stock now, and the valuation looks reasonable right now. As I mentioned above, if the price drops to book value, this could be a real steal. The real estate is already undervalued (although it's hard to unlock that value) so the stated book value is likely quite conservative.

I don't know much about Eddie Lampert but I have a lot of respect for him. Ever since I read about him being kidnapped at gunpoint, only to recover and make a great deal, I gained a lot of respect for him and have been watching his moves at Sears. Some say he is one of the best capital allocators out there. The example I remember was someone saying that he somehow managed to buy back stock near the lows again and again (in contrast, most executives don't know what the hell they are doing and sometimes end up buying back stock at highs). Eddie Lampert is also a through-and-through value investor in trying to minimize costs down. Unlike Buffett, however, he is a control investor who actually studies the business and involves himself in the day-to-day operations.

I haven't looked into Sears deeply so I won't comment on its future (I'm not into shopping but its brand is unspectacular from what I gather--I'm in Canada though, where Sears actually is doing OK compared to the US). I am attracted to the stock due to its low valuation more than anything to do with its brands or corporate strategy. I've been looking for a retailer (this is the other big industry that is selling off these days) and SHLD is one of the most attractive out there. I still need to do some homework (SHLD probably has one of the worst investor relations website on the planet. There isn't even an e-mail contact to request investor kit or any docs. Even Japanese companies have better English websites :( I guess SHLD is run like a hedge fund with minimal info)...

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