Sears Hometown and Outlets Quietly Improves

The Sears Holdings spinoff isn't performing great, but its operations are better than its stock price would suggest.

Apr 7, 2014 at 1:54PM

Sears Hometown and Outlet Stores (NASDAQ:SHOS) has been plagued over the last several months by a variety of factors. For one, the stock shares a name with one of the most polarizing (though largely negatively viewed) public companies on the market -- Sears Holdings (NASDAQ:SHLD). Sears Hometown and Outlets has also had a sluggish transformation, erasing much of the optimism that brought the stock to a near double from its spinoff price. Recent results don't show much in the way of improvement, but investors who read between the lines will see that the company's previously heralded operating advantages are indeed working. Here's what investors need to know.

The year in review
For a company whose stock shed nearly 40% of its value in the past 12 months, Sears Hometown and Outlets' business has plenty to rally behind. In the past year, sales fell slightly more than 1%. Driving that decline was a systemwide same-store sales decline of 2.2%. There are a couple of things to keep in mind here, though. For one, Sears Hometown stores has exited the consumer electronics business -- a wise move. That puts the year-over-year comps at an immediate disadvantage. Excluding consumer electronics, Sears Hometown sales declined 1.5%. Outlet sales increased 1.4%, giving a systemwide net decline of 0.8%.

For a year in which numerous retailers have struggled with a stingy consumer and extreme weather across the country, these numbers really aren't bad.

The business model is working. One of the best parts of Sears Hometown and Outlets is its franchise-based store footprint. As the stores have largely been converted to franchise-owned locations, initial franchise fees have gone from $11.2 million to $25.6 million. Major appliances, the best segment for both businesses, are performing well with positive comps.

Appliances are a great deal for the company because it has a beneficial supplier arrangement with its former parent, Sears Holdings. Sears Hometown and Outlets is able to unload its unsalable appliances (defected, damaged, etc.) back to the company at cost.

For the year, operating and net income took substantial hits. Aside from the decreased sales figures, this is due to some short-term margin pressure. Sears Hometown and Outlets' franchise conversion process costs money up front (largely offset by franchise fees but nonetheless affecting margins), but these factors should subside in coming periods. As the business transformation is completed and the transition costs go into the rearview, expect the continuing operations to shine a bit brighter.

Made for shareholders
Sears CEO Eddie Lampert has strategically placed the company's best assets into separate businesses (most recently including Lands' End) so as to allow those assets to shine, to allow investors to pick and choose which parts of Sears they like, and to give greater focus on the core Sears Holdings businesses. Sears Hometown and Outlets is one of these bright spots. The company sells a variety of high-performing brands such as Kenmore, Craftsman, and DieHard.

The business hasn't performed as strongly as expected, but the long-term fundamentals remain strong here. The stock recovered from its basement-level lows, but substantial upside exists for the long-term-oriented investor. Keep an eye on this underfollowed, unloved retailer. It may surprise you.

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Michael Lewis has no position in any stocks mentioned. The Motley Fool owns shares of Sears Hometown and Outlet Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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