Thursday, May 29, 2008 0 comments ++[ CLICK TO COMMENT ]++

Sears Posts Large Loss

A stock I'm thinking of investing in, Sears Holdings (SHLD), posted an unexpectedly large loss. Consensus (Bloomberg) expectations of $0.15 were missed and the actual results were a loss of -$0.53. The stock was only down around 3.6% for the day so most of the negative news had been expected somewhat.

Sears Holdings Corp. posted an unexpected first-quarter loss as it increased discounts to clear merchandise in the face of increased competition and a softening economy.

For the quarter ended May 3, the Hoffmann Estates, Ill. parent of the Sears and Kmart chains posted a loss of $56 million, or 43 cents a share, from net income of $223 million, or $1.45, a share, a year earlier.

Shares outstanding fell 14% to 131.7 million. Revenue fell 5.8% to $11.07 billion from $11.75 billion. Excluding gains from sales of assets, the company's loss would have been 53 cents a share.

Analysts, on average, estimated the company would have earned 21 cents a share, according to FactSet Research. Sales also fell short of analysts' estimates of $11.3 billion.

Analysts have been completely wrong on this stock for a while, although most have been correct in the recent past with their sell/underweight/hold recommendations. Sears is heavily dependent on housing-related sales (white-box items such as appliances) so it isn't that surprising to see a big decline in sales. However, it has been underperforming the low-cost competition such as Wal-mart and Costco (admittedly those two only overlap in certain segments).

U.S. comparable-store sales fell 8.6%. U.S. same-store sales, which reflect results at stores open at least a year, fell by 9.8% at Sears and by 7.1% at Kmart. Demand weakened across most major categories, especially within the home appliance, lawn and garden and apparel areas, Sears said...

Its gross margin narrowed to 27.3% from 28.2%, the retailer reported.

Pretty weak numbers but I'll be curious to see what happens once housing stabilizes. Right now, they are neither the low-cost retailer (eg. Wal-mart) nor a higher-end one with quality and cachet (eg. Macy's). The weakening economy has hurt the middle segment more than the rest so far and it remains to be seen how much worse it gets.

Here are some excerpts from a bearish post from a bear who touches on the key themes surrounding Sears:

(source: Evan Newmark, Mean Street. WSJ Deal Journal blog)

Today’s awful earnings announcement confirmed the company’s many failings.

But the failings of Sears also reflect the failings of Wall Street. It is a textbook case of how Wall Street can promote a stock based on wishful thinking and myths rather than on the performance of the core business.

Until the core business deteriorates to a point where even Wall Street can’t promote the stock anymore.

A year ago, a share of Sears Holdings traded at $183. Today at $86, it trades at less than half that. How many of the half-dozen sell-side analysts saw it coming? None.

Sell-side analysts tend to be short-term-oriented with a 12 month stock price focus. I like to look at them from a contrarian view, where I prefer to have sell/underperform ratings than buy ratings. Most analysts are now bearish on Sears so that's good from a contrarian point of view for anyone that is contemplating a position in it.

For what it's worth, a lot of successful value investors are long Sears:

Ironically, along with Cramer, it has been other “genius” investors that have been Lampert’s biggest believers. Sears largest shareholders include Bill Miller of Legg Mason, Bruce Berkowitz of the Fairholme Fund, Richard Perry of Perry Capital and Bill Ackman of Pershing Square. That is a lot of genius invested in a shrinking retailer run by a hedge-fund manager. These managers may have investing angles they aren’t ready to reveal, but so far they have publicly voiced support for Lampert.

That's pretty good company to be in... but it doesn't mean that this is a good investment.

When I was trading shares last year, I tried shorting Sears a few times. Not a smart move. Sears trades like Amazon, another retailer with a high shareholder concentration and large short interest.

A handful of shareholders–Lampert, Legg Mason, Fairholme, Pershing Square and Perry Capital–control almost 75% of Sears’ outstanding shares. Couple this with a sizeable share buyback program and you get an erratic,volatile stock.

On a day when everything says Sears should be down, you often will get a dramatic late day run-up that probably is part buying and mostly short-covering.

If what this author is saying is correct, Sears' stock price would have been under even more pressure if it weren't for the concentrated shareholders. The upside is that the stock price may not drop too much; the downside is that if one of these main shareholders do decide to sell, the price can collapse easily.

But I wouldn’t be surprised to see the Sears share price continue to decline as the economy suffers. Down the road, when things look really bad, ESL could propose a buyout to take out the remaining public shareholders.

This is one of the risks with a major hedge fund owning most of the company: a take-under is more likely. However, this won't happen while the main set of present shareholders remain. Bill Miller is a patient, long-term, investor and unlikely to budge unless the price is good. And William Ackman is unlikely to sell out unless his own hedge fund is running into liquidity problems.


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