Is This Retail Spinoff a Solid Investment?

This newest spinoff from Sears looks to be one of the best plays in online retail.

Jun 23, 2014 at 3:40PM

Lands' End's (NASDAQ:LE) first quarterly results announcement since being spun off from Sears Holdings (NASDAQ:SHLD) shows that the company is growing nicely and may well be the future direction of retail. It didn't have any excess expenses related to the spinoff. Despite having existed for more than 50 years, 11 of those in the dated portfolio of Sears, the business has a completely contemporary look given its virtual presence. And though it has a historical legacy of 265 brick-and-mortar outlets, mostly in Sears stores, more than 80% of its revenue is generated through catalog and online sales. Lands' End looks to be a solid investment in the retail space.

Online and brand strategy
The company uses the web much like the fashionable modern icons of e-commerce, with entertaining blogs, an innovative Tumblr, and 16,000 followers on Twitter, which is not that far behind the 27,000 that L.L. Bean has. The product image it strives for is "timeless style," and this has worked well, notably in categories such as blazers and short swim trunks.

The results speak for themselves
Last quarter, Lands' End's merchandise revenue grew by 3.6% to $330 million compared to $319 million for the previous year. Revenue in the direct-to-consumer category grew by 4.8% to $276 million because of growth in the U.S., while revenue in the retail segment declined 2.3% to $54.4 million because of a decrease in the number of stores. As of now, the company operates 251 stores within Sears stores and 14 stand-alone stores.

The gross margin percentage increased by around 0.6% to 49% year over year, and as a result, gross profit grew by 4.8% to $162 million. The increase in the gross margin percentage was driven by the direct segment and improvements in the merchandise assortment. Lands' End's balance sheet had cash of $65 million at the end of the quarter compared to $1.8 million last year. Inventory was down 5.4% to $327 million.

Continuing heavy dependence on Sears
Despite the spinoff, the company continues to be heavily dependent on Sears and its management. The retail segment, being a "store-within-a-store" concept, will not be successful if the Sears stores do not attract enough traffic or promote the Lands' End shops adequately. Lands' End is also dependent on subsidiaries of Sears, including the provision of staff to deal with in-store customers. Finally, Sears provides the critical information technology systems to support key services.

Lands' End has entered into several multi-year contracts with Sears, which makes it difficult to see any further scope for improvement in margins. According to one estimate, total fees payable in 2014 under these agreements could be in the range of $33 million to $36 million. On top of this, there is the debt that it has taken on to pay a special dividend of $500 million to Sears.

The positives
Lands' End will be free to operate for its best interest, which will give it a better chance to expand margins and grow revenue. It already derives more than 80% of its revenue from its online and catalog channels and is in a good position to be a winner in the new shift to multi-channel retailing. It also has the ability to downsize its brick-and-mortar business, which is currently losing money, and thus improve its overall performance.

Bottom line
Lands' End looks to be an attractive company in the retail space, but Sears could weigh down performance in the near term. Overall, assuming that Lands' End can reduce its exposure to Sears, it would be worth a closer look.

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Editor's note: A previous version of this article stated that Lands' End belonged to Sears for 50 years. The Fool regrets the error.

Marshall Hargrave has no position in any stocks mentioned. 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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