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After Rough Earnings, Sears Hometown and Outlets On Clearance

By Michael Lewis - Sep 3, 2013 at 8:39AM

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The Sears spinoff took a major hit last week on the back of a dreadful earnings report. Here's why it might be a good buy.

Sears Holdings spun off a portion of its business into Sears Hometown and Outlets (SHOS) roughly one year ago. Upon its market entrance, the company's stock took a near-vertical trajectory and didn't stop until the early part of this summer. Since then, things have taken a difficult turn, and the recent earnings report saw income halved and a tepid outlook -- sending shares down nearly 20% in just one day. It was not an all-around disaster of a quarter, which says much about the company's ability to move product during a terrible period for nearly all retail businesses. Furthermore, the fundamentals that made Sears Hometown and Outlets an appealing company are largely intact today. Here's why the company may be a buy on the precipitous drop in stock price.

Earnings recap 
For the second quarter, Sears Hometown and Outlets saw its income go from $0.91 per share in the year-ago quarter to just $0.40 per share. While there was no analyst coverage or estimate to compare to, the market clearly took the news in the worst way possible.

Revenue actually ticked up just under 2%, and same-store sales rose a respectable 1.4% over the prior year's numbers. The same-store sales mix shows a 0.4% decrease in sales at Hometown stores, coupled with an extremely impressive 8.2% increase at Outlet stores.

Sears Hometown and Outlets saw its home and garden division grow sales by double digits, alongside favorable growth in appliances, despite increasing competition in the retail appliance market.

The company also initiated a $25 million stock repurchase program.

Rosy view 
Admittedly, this article is downplaying the negative aspects of the earnings report. A more than 50% decline in operating and net income is frightening and extremely concerning. However, these results may be of a short-term nature, as the company still holds many appealing aspects.

The original investment thesisl behind Sears Hometown and Outlets was that it was a complicated, misunderstood spinoff from its parent company and had several qualities that made it a better buy than its parent. For one, the company has focused on franchising its Hardware stores, aiding gross margins and reducing expansion costs. The Outlet stores have a favorable merchandising arrangement with parent Sears Holdings, in which unsalable goods (from Sears Holdings) can be sold back at cost, protecting the company. The Outlet stores are also in their infancy, with many more to come across the United States.

While the "misunderstood" portion of the investment thesis has been somewhat negated over time, the other underlying qualities to the stock remain. As the retail environment improves and the cash flows from franchising tick higher, the market may adjust its dour view of the business.

Back down to its lowest levels in several months, Sears Hometown and Outlets offers investors a compelling opportunity at a low, low price.

Fool contributor Michael Lewis 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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