Thursday, May 22, 2008 5 comments ++[ CLICK TO COMMENT ]++

Sears Holdings Hitting Attractive Levels

Sears Holdings (SHLD) is hitting price levels that are quite attractive. I've been looking at Sears (and other retailers) lately. I have mostly looked at Sears from a credit point of view because I'm still thinking that the 7% Notes due 2042 trading on the Pink Sheets under the SBCKP symbol may be worth it (the concern is inflation more so than bankruptcy/default risk).

Sears is a good contrarian retailer to investigate. It's one of the retailers with bearish Street consensus. According to Yahoo Finance, 3 analysts rate it a Hold (a polite way of saying sell) and 4 rate it Underperform (more direct indication of a sell). Analyst median target is $87/share with a low target of $70. The current price is getting close to the $87 target.

I've also been waiting to see if I can consider buying it below book value. Given that some prominent investors, such as William Ackman, have indicated that real estate on Sears' books is understated, buying below or close to book value is almost a home run. Right now Sears is trading around 1.1x book value. Another 10% drop in book value (or 10% additional profit) will hit the 1x ratio.

The big downside is the credit contraction (started by the housing meltdown but likely to spread to credit card usage) and its negative impact on consumers. Sears seems to be one of the weaker deparment stores in terms of brand, shopping appeal, fun factor (yes, some people, especially women, consider shopping fun ;) ), and prices, so it will likely suffer more than some of its competitors. But its balance sheet is strong so it can easily absorb significant deterioration with their customers.

In terms of upside, I think an optimistic upside scenario (ignoring financial engineering with the real estate assets) is a profit margin of around 3%. Right now Sears has around 1.5% profit margin so you are looking at 2x increase in earnings. The TTM P/E is 15.5 and forward P/E is 24.8 so the optimistic case yields a P/E of around 12 (using the forward P/E). Earnings for nearly all retailers are likely below-normal levels so earnings will be higher over a full cycle with economic slowdown along with recovery thereafter.


5 Response to Sears Holdings Hitting Attractive Levels

May 23, 2008 at 2:03 AM

Something to consider: it may not be an accident that this year Bill Miller / David Dreman / Martin Whitman all have had their faces ripped off bottom-picking and averaging down on quite a few value traps (ABK, MBI, BSC, AIG, CFC, homebuilders, regional banks, FNM/FRE, etc.). Most of these guys made their name doing what they are doing now back in the early 90s in the last credit crunch. Their knee-jerk reaction to think that this credit crunch is similar to the last one is the chink in their armor.

I have a theory: all these guys were lucky the last time they bottom-fed on in the early 90's: they got bailed out by Alan Greenspan. In other words, they mistook a lucky break for a "proven" contrarian investment methodology.

Well, there is a chance this time it _is_ different. Maybe this time Bernenke won't be able to bail these value guys out as they bottom-feed on the financials.

We'll just have to see.

PS: I'm short practically everything that Miller, Dreman, Whitman owns.

May 23, 2008 at 2:04 AM

PS: I really do hope you don't make the mistake investing in SHLD as you did w/ the ABK disaster.

May 23, 2008 at 10:58 AM

Sears won't be anything like Ambac. I remember quoting someone who said that they will never invest in MBIA because it is a type of investment than can go to zero. Sears is the type of company that likely won't. It doesn't mean that one won't lose money but it isn't the same situation. Ambac/MBIA/CFC/etc have insolvency risk whereas Sears doesn't and likely won't for 5+ years. At worst, I think there may be several years of underperformance (that's one reason I'm looking at the bond instead--it pays you to wait).

I think you raise an important point about the current situation being different from the past. I have thought it through and I think the onus is on your side to prove the case. You likely can't prove your case until well after the fact, in hindsight.

I think someone like Bill Miller may be vulnerable to what you are saying i.e. investment success based on the booming 90's, declining interest rates, low inflation, etc. But I think you are likely incorrect when it comes to David Dreman, Martin Whitman, and guys like that.

One of the reasons I think Whitman/Dreman/etc know what they are doing is because they actually started investing back in the 70's (I think 60's for Dreman--not sure). They haven't been spoiled by the 90's; they developed most of their skill back in the 70's/early 80's. David Dreman's first few key book on contrarian investing was written in 1977 and 1980. Martin Whitman became famous after starting his mutual fund in 1990(?) but he was investing long before that. Given that the 70's were the worst investing time period (in real terms) for investors, I am sure they are aware of how the 90's and early 2000's fits within history.

The other reason I think they should be fine is because they are contrarian investors. Yes, you can end up catching falling knives but these guys are extremely talented and have proven that they can evaluate businesses on a case by case basis. For instance, even though the declining interest rates, strong GDP growth, etc, in the 90's helped the investing climate, guys like Whitman and Dreman made their money on the out-of-favour stuff. I mean, Whitman's #1 investment of all time (from the 90's) is Nabor industries, which if I'm not mistaken is an oil&gas driller, that was totally out of favour. When he invests in MBIA, it's a similar situation but the insolvency risk is much higher in my eyes (since there are hard to pin potential losses from insuring risky assets).

I think they will be fine if there is an inflationary period like the 70's. It won't result in high returns but they should outperform. Some of Warren Buffett's best investments in the 70's even though he never touched the booming commodities or shorted stocks. But what can hurt those guys as well as people like me--and I think this is what you are concerned about--is a massive credit bust beyond the current housing bust. But that's hard to predict and that's why I say you are no more right than I am. The structure of the economy is very different from the past, with service industries being more flexible and wage growth fairly low.

It would not surprise me if Martin Whitman (long) makes more money on MBIA than William Ackman (short) when it's all said and done (assuming MBIA doesn't go bankrupt :) ). Shorts only have 100% upside versus potentially higher for longs. But I'm not here to diss your strategy. If it works for you, go ahead. I think your success will depend on when you shorted some of the stocks.

May 28, 2008 at 7:18 PM

I keep my shorts (the anti-Dreman/Whitman/Miller stocks) on a "short" leash -- tight stops. When you short stocks, you have to trade them and dance around short squeezes, that's part of the risk that I take and manage -- but that's the key -- I am manage my risk.

I used to own mutual funds run by Dreman and Whitman, but I got out of Dreman in the early 2007, and Whitman in November 2007.

What prompted me to get out of Dreman in the early 2007? As the subrpime crisis was unfolding in real time, i saw his portfolio is littered with gems like Novastar Financial, Newcastle, American Home Mortgage, WAMU, Freddie/Fannie, etc. He never got out of them until they imploded. That told me he never saw the credit bubble coming and didn't understand it and its implication. To this day he is still recommending Fannie/Freddie in his Forbes articles - as he has 15 years ago. If you had followed his recommendation on Fannie/Freddie 15 years ago, you would have made nothing.

I'd say Whitman is a better manager. But his investment in MBIA and ABK is what spooked me out of his mutual funds in November 2007. Or more specifically, his _rationale_ for investing in MBIA and ABK is what spooked me: he actually believe their investment merits or intrinsic value can be made based on the _book value_ of these financial companies. Then he averaged down on MBI and ABK as they imploded. I can't help but remember Paul Tudor Jone's advice: Only losers average losers.

May 29, 2008 at 4:24 PM

ANON: "I can't help but remember Paul Tudor Jone's advice: Only losers average losers."

That is what seperates short-term, momentum, investors such as yourself from long-term, value-oriented, investors. Value investors nearly always average down into losers. If you check the history of Buffett, Templeton, Miller, Whitman, et al, you'll see that they average down into their losers...

But short-term investors rarely average down. In fact, technical investors, who tend to be momentum investors, avoid averaging down.

I think you are wrong about Dreman's Fannie Mae call a decade ago. You would have made a killing on Fannie and Freddie until the last few years. They were up around 1000% to 5000% depending on how far back you go. Plot FNM from 1990 to now.

I can see what you are getting at but I may be biased since I'm the one who invested in Ambac, and is considering others like Sears. You obviously disagree but I don't see anything wrong with how Whitman values MBIA and Ambac (mind you, that's how I also look at it). Book value is probably a better indicator of insurance companeis than anythign else. That doesn't mean you won't lose money but how else would you value it? Based on the whim of what you think may or may not happen?

Anyway it's times like this that seperates the best from the rest... it's also what sets up contrarians and value investors for the big gains later on... let's see what transpires...

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