Sears Holdings: Don't Ignore the Balance Sheet

When Sears Holdings (NASDAQ: SHLD  ) announced weak earnings after the market closed on Jan. 9, investors panicked again ignoring the facts of the company. Investors need to understand that Sears only reported the income statement numbers. If one remembers Accounting 101, the actual valuation of a company is based on the balance sheet or the assets minus the liabilities. The income level each quarter adds or subtracts from the equity on the balance sheet, but a large loss doesn't necessarily destroy assets forever. In the case of Sears, the balance sheet is littered with hidden assets that are overshadowed by these weak retail results.

Even for somebody bullish on Sears, the numbers were almost horrific. The company clearly had a bad quarter. Sales were likely affected by a reinvigorated J.C. Penney (NYSE: JCP  ) and online sales to Amazon.com (NASDAQ: AMZN  ) . The latter might be a problem, but the stabilization of the former actually improves the valuation of the primary assets on the Sears' balance sheet.

Horrific Holiday Numbers
While Sears continues to tout the development of digital and social relationships with members, the company reported that fourth quarter sales are trending toward comparable sales declining 7.4%. Even more horrific were the Sears Domestic drop of 9.2%. The huge decline in sales is leading the retailer to forecast a net loss of up to $300 million. With analysts previously projecting a small gain for the quarter, the sudden drop to a large loss is disappointing.

Part of the flop at Sears might be directly correlated to the sharp turnaround at J.C. Penny. During the third quarter, the company reported that comparable sales only declined 4.9% with Oct. turning positive. An initial read on the Thanksgiving period generated comp sales at 10%, though the company is still sticking to the guidance for sequential improvements. All of these numbers are dramatic improvements over the prior periods and are likely indications that J.C. Penny is taking traffic back traffic lost to Sears over the last couple of years.

Another issue facing box store retailers is the substantial gains generated by Amazon.com. Analysts forecast 22% growth, but more signs exist that many shoppers ordered gifts online due to the bad weather prior to Christmas. In that scenario, Amazon.com gained market share from shoppers not going to malls.

Hidden assets
The assets aren't completely hidden, but in a lot of cases accounting rules prevent listing the value of assets based on market value. In the case of real estate, it hasn't been marked up to the current day values. Instead of spending lots of time trying to reinvent the wheel, small investors can take advantage of a detailed research report like the one from Baker Street for a starting point. Using that research, Sears Holdings has the following assets with these assigned values:

  • Real estate = $8.6 billion
  • Brands = $2.5 billion
  • Home Services = $1.9 billion
  • Lands' End = $1.4 billion
  • Sears Online = $1 billion
  • Sears Canada = $0.9 billion
  • Sears Auto = $0.5 billion
  • Retail = ($3.6 billion)

The above values tie to the mid-point values assigned by Baker Street back in October. The company saw plenty of potential upside on the real estate. Based on those numbers the research firm came up with a total value of $13.9 billion or $131. A larger loss for the holidays only adjusts the retail part of the asset equation lower. Are the retail operations now worth a negative $4 billion? If you decrease the numbers to negative $4.5 billion for the retail operations, the value of the assets is now down to $122.

Real estate redevelopment
A primary thesis of the Baker Street research is that the real estate assets most likely have a valuation far in excess of the $8.6 billion. In fact, research suggested that the redevelopment potential in the top 350 properties would boost the value to $12 billion.

A major reason for the rich valuation is a sudden decrease in prime locations at premier malls where Sears has stores. The J.C. Penney rebound could actually boost the Sears real estate values. Since both are located at the same malls, any collapse by J.C. Penny could place a ton of inventory on the market at the same time. Sears would rather see J.C. Penny rebound by stealing traffic back and leave Sears to redevelop the only available store space.

Note that Sears and Simon Property Group have similar square footage totals if anybody wants a second opinion on what the real estate would be worth rented to somebody other than a Sears. Simon Property is worth nearly $50 billion suggesting a $12 billion valuation by Baker Street might be at the low end.

Bottom line
Naturally these negative retail numbers subtract from the substantial assets held by Sears. Going forward, Sears could lose up to $10 in value annually if it continues losing this much money, but investors need to remember that the assets could gain as well offsetting the retail weakness. Investors need to understand that the stock could go substantially lower as investors obsess over only the retail portion of the balance sheet. In the end, the ultimate value of Sears will be derived by all those different division outlined by Baker Street. Investors can take those numbers and adjust them in whichever manner they deem appropriate, but everybody needs to understand that the income statement is only a small fraction of the story.

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Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

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  • Report this Comment On January 12, 2014, at 12:05 PM, Dangremaus wrote:

    Thank you for posting this! This is exactly what Lampert and his management team is looking at.

    People keep comparing Sears and JCP, but in reality Sears knows it won't survive and is just waiting for the leases to be up so they can shut down the stores and re-rent them out. Unfortunately, real estate leases take a long time to expire, which is why this is all taking forever.

    Management at Sears is NOT trying to redo its image, nor is it trying to reinvest in a turnaround because it doesn't want to. It knows it can't compete with Amazon.

    Lampert's news release the other day was a ploy to scare everyone out of the stock so he can finish accumulating it on the cheap.

    Once he accumulates to a certain point, he can take the company private and the media won't be able to take punches at him anymore.

    People laugh at Lampert for running the company into the ground, but you have to ask yourself the question "Why would a billionaire CEO staffed by intelligent advisors not find a plan for the company in 9 years?" The answer is, "They have. Few people see it."

  • Report this Comment On January 13, 2014, at 8:34 AM, G13man wrote:

    "Lam"-pert can have these losers . I will not shop at either or for their " brands" . last time one of these divisions went bankrupt , they stole the share from the shareholders to refinance themselves and merge . And craftsman tools do not honor their lifetime warranties [@least 4 me ] . Kenmore is manufactured by some one else . .Malls are dieing , so that real-estate is not worth as much as they say [ask Detroit]

  • Report this Comment On January 13, 2014, at 2:41 PM, MSFInvestments wrote:

    I don't think Eddie will take the company private. He is the largest shareholder so he will do what is best for them.

    The retail will be about KCD and downsized. The rest about the holdings like this one. www.seritage.com

    Lahiem

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