As horribly as Sears Holdings (SHLDQ) has performed as a retailer, and one only has to look at the company's recent earnings release or 10-year chart to see just how bad things have been, it doesn't matter to big investors or CEO Eddie Lampert. They don't care because Sears Holding is like a stealth retail real estate investment trust (without the yield), and their holding time frame could be considerably longer than a small investor's.
Sears Holdings total return price data by YCharts
The land endures
Lampert has been selling and spinning-off assets for several years; as Brian Sozzi of Belus Capital Advisors put it, "starving the store base." The thesis is that the sum of the parts is worth much more than a going retail concern: 241 million square feet of real estate, the trademark brands Craftsman, Die Hard, and Kenmore, internet and warranty businesses, and private-label apparel brand Land's End. But mostly the land.
Sears' stock rose by double digits after Baker Street Capital issued a 139 page property-by-property appraisal in September, concluding that Sears' top-400 locations could net more than $7.3 billion if sold. Including the 500 remaining locations, Sears Holdings' real estate portfolio is conservatively (the company's word) worth $8.3 billion.
Baker Street went further, saying $44 per share is only one-third of the company's breakup value. The firm claims its analysis is conservative, excluding the significant value in real estate redevelopment opportunities.(Note: Baker Street is a large stakeholder in Sears at 1.5 million shares, and this analysis only included mall-anchor spots.)
A REIT and not a retailer?
With the creation of Sears' subsidiary Seritage Realty Trust in 2012, headed by former Kimco Realty COO David Lukes, it appears Lampert is running a retail REIT without yield. The same Baker Street report gave several examples of Sears' repurposing and subleasing space in stores across the US to gyms, grocers, etc. It also noted how Sears is shuttering non-performing departments like grocery and pharmacy in some KMarts.
Baker Street's main point is its 84-20 thesis that 84% of value is locked up in only 20% of Sears Holdings' property, mostly mall anchors in A (or top-tier) malls. The firm believes these could easily be sold-off without drastically affecting the rest of the business, and prime mall space demand is sufficient being a margin of safety for investors.
Several foreign retailers like H&M and Uniqlo are expected to expand their US retail presence, according to General Growth Properties CEO Sandeep Mathrani. Recently, Restoration Hardware announced it was offered more than 30 anchor deals in top malls, so there are sizable retailers that could fill anchor spots seamlessly.
Baker Street pointed out that Lampert has added 50% to his Sears Holdings stake with his own money over the last two years. Bruce Berkowitz of Fairholme Capital Management told Fortune in 2012 , "The value of Sears would be over $160 a share if the land on the books was fully valued." Berkowitz holds 20.4 million shares, up from 16 million-plus shares earlier this year.
On Sept. 4, Berkowitz asked CNBC , "How can you have Sears selling where it is and compare it to Simon Property? Sears has more square footage than Simon Properties. We have something that is extremely valuable."
Gone in five years
Valuable, but not as a retailer. Sears Holdings is performing worse than J.C. Penney (JCPN.Q). J.C. Penney may have lost up to 1.5 million of its core customers during its "transformation" under Ron Johnson. Gross margin is actually worse at Sears Holdings at 25.4%, lower than its five-year historical average of 26.8%, and lower than J.C. Penney's current 29.6%.
J.C. Penney's return to coupons and promotions is looking more promising for sales, even as aggressive promotions and coupons hit Sears Holdings' gross margin by 210 basis points.
Sears Holdings' revenue dropped from $43.3 billion in 2010 to approximately $39.6 billion in 2012, and earnings per share fell from $1.44 in 2010 to -$26.68 in 2012. Same-store sales have declined for seven years straight. As Sozzi noted, Sears -- the retailer -- could be gone in five years saying, "Sears becomes more irrelevant by the day."
Baker Street's report values Sears Holdings at more than $100 per share on its real estate. One of the few remaining analysts covering Sears, Gary Balter of Credit Suisse, was quick to reiterate his Underperform rating and price target of $20.00.
Balter justified the difference in his best-case scenario price (and before ongoing operating losses) of $38 versus Baker Street's $100-plus:
The material differences lie in four main buckets, real estate values, the value of the Internet and warranty businesses, the liquidation value of working capital and the lack of inclusion of continued multi hundred-million dollar cash flow losses while the business operates.
A "managed retreat?"
In 2012, Sears Holdings spun off Sears Hometown and Outlet Stores, 44% of its Sears Canada (SEARF) business, and its Orchard Supply Hardware Stores. The Sears Hometown and Outlet Stores are committed to buy Kenmore and Craftsman products, although at cost.
Despite Hail Mary plays like bringing Paul de Podesta of Moneyball fame on the board, Michael Santoli, senior columnist for Yahoo! Finance and longtime Barron's contributor, still characterizes Lampert's handling of the retail operations as a "managed retreat."
Santoli said Lampert's reluctance to refresh Sears and KMart stores a la J.C. Penney was actually a good thing. Efforts to fend off increasing competition from Wal-Mart,Target, and Macy's would be a waste a capital, Santoli reasoned..
If not now, when?
Neither Berkowitz nor Baker Street has answered the big question: when will this land rush for Sears' properties happen. KMart merged with Sears in 2005, so how long is Lampert willing to play "chicken" as the retail stores gradually wither and die?
Sears Holdings may be a dead retailer walking, but as a quasi-REIT it looks interesting. Since it only created its Seritage Realty Trust last year, any land grab probably isn't likely in the immediate future. However, it is obvious that Berkowitz and Lampert are adding significantly to their stakes. The main question investors must ask themselves is can they out-wait Berkowitz, Lampert, and Baker Street?
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