Investors Ignore the Benefits of the Lands End Spinoff. Here's Why You Shouldn't

Reinvigorating store growth, international expansion, and brand identity are some of the prime benefits of spinning off Lands' End which have been ignored by the market.

Apr 24, 2014 at 2:00PM

The recent negative reaction to the Lands' End (NASDAQ:LE) spin-off from Sears Holdings Corporation (NASDAQ:SHLD) has unfolded similarly to traditional spin-offs in the past. The market continues to focus on the past results of Lands' End to justify its current valuation while at the same time it has overly focused on the company's connection to Sears Holdings.

Lands' End is a specialty retailer that mainly focuses on web and catalog sales. Sears bought the company back in 2002 for $1.9 billion in cash. Over the years Sears started placing Lands' End stores within its department stores, but this hasn't helped stop the recent slides in revenue for either retailer.

The real question is whether the tie to Sears will hold the stock back or will the unleashing of a now laser-focused, spun-off brand reignite growth.

Lost identity
The bull case is that the identity of Lands' End had been lost over the last several years with the retailer operating under the large umbrella of Sears. While Lands' End will still utilize space at Sears' headquarters and the successful Shop Your Way customer-loyalty program, it has limited connections to the actual Sears stores.

The big misconception is that Lands' End's sales depend on Sears Holdings. The retailer actually only obtains 16% of revenues from the Lands' End Shops within Sears store locations. Currently, it operates 275 stores, though this is down from 292 in 2010.

With only 16 Lands' End Inlet stores that are not connected to those of Sears, the retailer now has the opportunity to focus its store growth on better locations that don't depend on Sears. In addition, the international sales of Lands' End have not expanded lately because of the lack of focus from the domestically aligned parent. Lands' End's international locations in the United Kingdom, Germany, France, Austria, and Japan only account for 16% of its revenue. Expectations call for the company to expand in its existing international markets and develop presences in other locations such as Switzerland, Russia, Scandinavia, and China.

The lack of store development and international expansion provide solid growth opportunities which had not been previously explored under Sears' umbrella.

Intriguing valuation
With the sell-off following the distribution of its shares on April 4, Lands' End provides an intriguing valuation. The stock is now only worth $830 million while the company generated $1.56 billion in revenue during 2013. The company's past earnings numbers aren't nearly as meaningful considering the split, but the company did improve its net income to nearly $80 million because of an 110 basis-point gross margin improvement and a substantial decrease in operating expenses.

As with any spin-off, the company will now incur additional operating costs from incremental expenses related to its headquarters and the fees related to the customer-loyalty program. On top of that, the $500 million loan that Lands' End has taken out to pay the dividend to Sears will cost the company around $22 million per year. According to Matt McGinley, an analyst at ISI Group, Lands' End would've earned $1.63 per share in 2013 based on the increased interest costs and operating expenses.

Bottom line
Lands' End currently has an attractive valuation, especially considering the retailer's potential return to growth mode via new stores and international expansion. Investors need to be ready for a few volatile quarters ahead as the company implements new strategies. Lands' End won't be able to enter new markets overnight, but the current valuation offers plenty of incentives and upside for the stock.

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Mark Holder and Stone Fox Capital clients own shares of Lands' End and Sears Holdings. The Motley Fool has no position in any of the stocks mentioned. 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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