Sears on a Downtrend With No End in Sight

Sears Holdings Corp. (NASDAQ: SHLD  ) stock has been exhibiting extreme volatility of late. From a high of $64.93 achieved on Nov. 26, 2013, the stock has taken a nosedive to trade at the current $47.61, a massive 27% drop in just a fortnight. Mind you this happened in a largely flat market. In sharp contrast, J.C.Penney (NYSE: JCP  ) , another ailing retailer, seems to be on course for an impressive turnaround and its shares are on the mend. It's only fair then to expect Sears' investors to wonder what is causing the downward spiral, and whether there is any respite in sight.

Many investors are aware of how badly this big box retailer has been ailing. Sears' stores have been hemorrhaging, and the gravity of the situation was clearly demonstrated by the firm's awful third-quarter results. Revenue for the quarter fell 7% to $8.3 billion, with the net loss attributable to shareholders coming in at $534 million, or $4.70 per diluted share. The loss badly missed mean analysts' forecasts by $1.64. CEO Eddie Lampert attributed the escalating losses to the firm's transformation to a member-centric retailer leveraging its Shop Your Way, or SYW, business model. 70% of Sears' revenue now comes from its SYW customers, up from 65% a quarter ago. Since Sears merged with Kmart in 2005, sales revenues have been on the decline for a shocking 27 straight quarters. 

It's quite disturbing that a cross-section of analysts, including Morningstar's Paul Swinand, hold a very unflattering view of Sears' retailing prospects. It was earlier expected that an improvement in macroeconomic conditions, and a resumption of normal consumption patterns would benefit Sears' leading categories such as hardware, appliances and automotive, and help to bolster store traffic while improving sales revenues and margins. But Sears' competitors seem to be benefiting from improving economic conditions, while Sears continues to ail. Mr. Swinand believes that Sears' fair value is only $10 per share. Credit Suisse analyst Gary Balter reiterated his 'Underperform' rating on Sears shares after the controversial Baker Street report, with a $20 price target. 

Huge insider selling
But Sears' latest sell-off is not due to the lackluster results, but rather due to two other key developments: huge insider selling by CEO Eddie Lampert, and the planned of sale of Sears' Lands' End property.

Eddie Lampert recently cut down his 55.4% Sears majority holding through his ESL Partners fund, to a minority holding of 44.8%, after selling $7.4 million shares worth $445 million. Mr. Lampert was quick to reassure Sears' investors that the sale was only meant to meet redemptions from his fund, and was not due to a lack of confidence in the firm and its ongoing restructuring efforts. But Sears' investors still took a dim view of the huge insider sale, and the shares fell 7.7% to trade at $51.30.

Real estate sales
The highly controversial Baker street report  of September claimed that over 90% of Sears' investors view the firm as a great asset play, rather than a good turnaround bet. That figure could be a bit exaggerated, but the stomach-churning volatility shown by the shares whenever there is some anticipated sale of its real estate tells you that the share price hinges strongly on expectations of the firm unlocking value for shareholders through sale of its properties. The shares had earlier rallied massively between August and October this year, as investors expected yet another bad quarter to push Sears' management to start selling its real estate properties.

Sears' bought Lands' End in 2002 for $1.9 billion. But Mr. Lampert recently said that it is highly improbable that the firm will get anywhere near that figure when it sells the property. Lands' End was a major brand back then, but has now been relegated to the sidelines. Investors are of course unhappy with this kind of news, and they have been quick to show their displeasure by punishing the shares.

What is the real value of Sears' properties?
LA hedge fund Baker Street published a glowing 139-page report in September, that valued Sears' real estate properties far above average consensus estimates. But other analysts, including ISI Group and Credit Suisse, do not share Baker Street's optimism, and think the properties are worth far less than what Baker Street claims. If the Lands' End story is a fair indication of what to expect, then these bearish analysts could be right. Given that there aren't that many department stores that are looking to expand nowadays, even Sears' prime locations might not fetch as much as earlier hoped for. The sad truth is that Sears' real estate portfolio could be worth much less than what its bulls think.

Sears Holdings: Two different views
Below is a side-by-side comparison of the valuation of Sears' appraised properties by Sears bulls Baker Street, and bears Credit Suisse.

 

Bull Case:

Baker Street

Bear Case:

Credit Suisse

Assets

   

Real Estate

$10.1billion

$3.2 billion

Lands' End

1.6

1.4

Home Services & Protection

2.4

1.0

Kenmore, Craftsman & Diehard

3.0

2.4

Sears Online

1.5

0.3

Sears Auto

0.7

0.5

Sears Canada

1.0

0.5

Others

0.9

0.3

Estimated Value of Assets (billions of dollars)

21.2

9.7

Value per Share

$169.0

$28.3

Source: Baker Street Capital Management, Credit Suisse

 
 

From the two valuations, you can see that Lands' End is valued at $1.6 billion by Baker Street, and just $1.4 billion by Credit Suisse. Both firms value the property well below its $1.9 billion purchase price. Credit Suisse' $28.30 valuation per share seems to be in line with that of many analysts. If this turns out to be the case, then Sears' shareholders are looking at a huge potential 42% downside from current share price.

J.C.Penney turning itself around
One worrying tone being echoed by many analysts is that Sears' competitors seem to be benefiting from improving macro-economic conditions, while the giant retailer continues to be a laggard. One of these beneficiaries could certainly be another ailing retailer, J.C.Penney

On the surface, it might appear as if there is a whole gamut of what's ailing J.C. Penney, but it really all boils down to a poorly executed sales strategy. Former CEO Ron Johnson had abruptly scrapped the firm's pricing policies that mainly involved marking up prices and then offering heavy discounts. J.C. Penney's large horde of bargain hunters was less-than-impressed by the new turn of events and store traffic nosedived.

But now there are several indications the beleagured retailer could be poised for a major comeback. CEO Myron Ullman declared on three separate occasions in October that there are clear signs of rising store sales. From a 30-year low of $6.35 reached in Oct.22, 2013, J.C.Penney shares have gained 33% to trade at the current $8.43. The ultra-low share price offers good entry points for long-term investors.Many analysts share the view that the shares are still grossly undervalued. The mean consensus price target for the shares is 10.10 with an average ''Hold'' rating. 

Bottom line
Sears' retail business continues to show major weaknesses with no real signs that the situation will change any time soon. Although there firm's online business is doing well and grew 17% at a time when same-store sales fell 2.5%, it constitutes just 3% of overall revenues. Sears has too much potential downside and this makes it a risky bet.


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  • Report this Comment On December 14, 2013, at 6:49 PM, HubbaBuba wrote:

    Kudos - you bet JCP is taking SHLD market share - and eating their lunch as well! SHLD "addition by subtraction" strategy has long been a loser - ON BOTH SIDES OF THE EQUATION! First, the shrunken new format SHLD store dreams are a bomb and there's "no there there" to fallback too. (A consequence of Lambert's retail hubris...) Moreover, the more they pick the low hanging fruit the less the equation has - PARTICULARLY WITH HIGH DEBT AND PENSION COSTS. SHLD is a "dead concept walking" and IMO awaiting an unfortunate (for the ORIGINAL US CRAFTSMEN workers, etc) bankruptcy in waiting. Bulls have LONG OVERESTIMATED:

    1.) Why any of the OVERSUPPLIED RETAIL MARKET WOULD WANT ALL THEIR "B" GRADE (AND FALLING) CAPACITY.

    2.) Given #1, that SHLD has many a property they can't even get out of properly.

    Another stupid move by them to be open 36ish hours over T-day. Yes, burn more opex all the faster on a failed by many diminsions master plan.

    Sears has long lost their raison d'être - and they can eat their excess industry over-rated capacity, and failed cash-flow opex too boot!

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