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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.
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.
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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