In some ways, the investment case for international department-store conglomerate Hudson's Bay (HBAYF) is similar to the case for Sears Holdings (SHLDQ) four or five years ago. Back then, Sears had a massive trove of valuable real estate and other assets that appeared to be worth more than its entire enterprise value.
However, Sears Holdings was consistently losing money and steadily burning through cash. The hope was that a turnaround effort could stem the losses and Sears would be able to enrich shareholders by selling off some of its real estate.
Of course, things didn't work out well for Sears shareholders. While the company did have lots of great real estate, it's had to sell the vast majority of its assets to offset ever-widening losses -- eventually leading to its bankruptcy filing last month.
Sears' valuable real estate wasn't enough to keep it out of bankruptcy. Image source: Sears Holdings.
Investors face a similar dilemma with Hudson's Bay, which has lots of valuable real estate but has been consistently unprofitable recently. Yet despite the apparent similarities to Sears, Hudson's Bay's real estate-centric strategy has a strong chance of success.
The debt is about to shrink dramatically
As of early August, Hudson's Bay had approximately 4 billion Canadian dollars ($3.1 billion) of debt and finance leases on its balance sheet. It also leases most of its stores from three joint ventures that it's formed over the past several years. Those joint ventures all have borrowings that don't show up on Hudson's Bay's balance sheet.
Several catalysts will drive steep reductions in this debt load by early 2019. Most notably, the sale of the Lord & Taylor flagship building is set to close within the next few months. Hudson's Bay has already received $100 million of deposits related to that deal. Upon closing, it will receive additional cash proceeds of $750 million (or $625 million in cash plus a $125 million minority stake in the building if the buyer so chooses).
Furthermore, in September, Hudson's Bay struck a deal to sell about half of its European real estate and operations to SIGNA Retail Holdings. While there are a number of moving parts involved, Hudson's Bay expects cash inflows of 411 million euros ($470 million), net of taxes. The deal also will substantially reduce Hudson's Bay's share of its European real estate joint-venture's debt.
Hudson's Bay also received CA$151.5 million ($115.4 million) last month, just for consenting to the redevelopment of a mall it anchors in Vancouver. (The Vancouver real estate market has been extremely hot lately.)
Hudson's Bay has cashed in on some of its valuable real estate recently. Image source: Author.
All of these deals, plus the normal cash influx that comes in the fourth quarter, should allow Hudson's Bay to slash its debt load by about half, while boosting its cash balance.
Hudson's Bay has one critical advantage compared to Sears
The upcoming real estate windfall could be a big turning point for Hudson's Bay. But skeptics might note that Sears Holdings has brought in billions of dollars of cash from selling real estate over the past five years and still fell into bankruptcy.
However, there's one key difference between the two companies. Whereas Sears and Kmart have both had terrible brand images for years, the Hudson's Bay chain has a dominant position in the Canadian department-store industry, and Saks Fifth Avenue remains a prestigious luxury brand in the U.S. Even the struggling Lord & Taylor chain is far better positioned than Sears and Kmart have been at any point in the past decade.
Hudson's Bay also has invested a lot of money on store remodels -- particularly for its flagship locations -- in recent years. This has contributed to its cash burn, but it has prevented the kind of customer-base erosion that doomed Sears Holdings.
A turnaround could be coming soon
A confluence of factors could drive a big improvement in Hudson's Bay's financial performance next year. The first is transaction-related: Eliminating the company's losses in Europe and reducing its interest expense should lift annual earnings by hundreds of millions of dollars.
Second, the company plans to close about 10 underperforming Lord & Taylor stores early next year. If Lord & Taylor can capture some of those stores' sales in nearby (profitable) locations, it would boost the bottom line.
Third, Hudson's Bay will complete a multiyear, $250 million makeover of the Saks Fifth Avenue flagship store early next year. Given that prime first-floor space was under construction this year, there's clearly room for this high-volume store to become even more productive in 2019.
In addition to these individual catalysts, new CEO Helena Foulkes and her management team have been taking a careful look at all aspects of the business in order to optimize the company's performance. Thus, Hudson's Bay could be on the verge of a sustainable turnaround, which could power a big comeback for its long-suffering shareholders.
