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Sears: Potential Downside Makes Stock a Risky Bet

By Anthony Maina - Oct 18, 2013 at 5:30PM

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Sears' bullish investors should consider the potential downside to the bullish Sears' real estate appraisal by Baker Street, and the fair value of the shares.

Sears Holdings ( SHLDQ ) stock has been extremely volatile of late. The shares had rallied more than 60% between late August and early October, in a largely flat market, to trade around the $64 range. Since then, the share price has been trending south to trade at the current $55.74, shedding about 15% in ten days.

The recent run-up should not be mistaken by investors to indicate an improvement in the giant retailer's beleaguered fortunes. Sears' shares had ramped up prior to the earnings call by such a huge margin mainly because most of its investors expected the company to post abysmal third-quarter results. This might sound ironic to an outside observer, but Sears, and its investors, are not your average company. According to the highly controversial Baker Street report that has Wall Street opinion about the company divided right down the middle, over 90% of Sears' investors see the company as a good asset play, rather than a good turnaround bet. Sears' investors expected another awful quarter to compel its management to start selling off key real estate properties.

Sears moves to unlock its real estate properties
The current downtrend has most likely been precipitated by the recent news that Sears had already sold off about 12 of its key real estate properties in the U.S and Canada. The sale of Sears' stores is aimed at unlocking value for its shareholders, and improving the firm's ailing cash flow.

Portfolio could be worth a lot less than what the bulls think
Baker Street is an LA hedge fund that published the glowing 139-page Sears report that valued its real estate properties at levels far above the average consensus estimates. There are other firms that were far less sanguine about the valuation of the firm's appraised properties, most notable being Credit Suisse and ISI Group. Below is a side-by-side comparison of the valuations by Baker Street and Credit Suisse. 

 

Bull Case:

Bear Case:

Assets

Baker Street

Credit Suisse

Real Estate

$10.1 billion

$3.2 billion

Kenmore, Craftsman & Diehard

3.0

2.4

Home Services & Protection

2.4

1.0

Lands' End

1.6

1.4

Sears Online

1.5

0.3

Sears Canada

1.0

0.5

Sears Auto

0.7

0.5

Other

0.9

0.3

Value of Assets (bil) 

21.2

9.7

Value per Share*

$169.0

$28.3

From the comparison, Baker valued Sears' real estate properties at $10.1 billion while Credit Suisse thinks they're worth only $3.2 billion. Although the two firms' valuations of Sears' other business segments show considerable variance, the difference is most significant here. Another firm that shares the bearish sentiment about Sears' shares is ISI Group, which places the fair value around $31 per share. The huge differences between these valuations have left Sears' investors wondering whose fooling who. The Online Barron makes bold claims  to the effect that Baker Street has a big interest in Sears.

Quality of Sears' stores
A Green Street analysis of Sears' mall-based stores found that only about 10% of Sears' stores were top-notch. The analysis was based on productivity and tenant roster, among other factors.


 Department store blues
Sears expects to record a $648 million loss this fiscal year, on revenues of about $37 billion. Its FCF was deeply in the red last year at -$707 million, with this year is expected to be only slightly better at -$600 million, according to predictions by Matt McGinley, an ISI Group analyst.

Sears' store sales of just $166 per square foot rank among the lowest in the retail industry. Its appliance business is getting beat by Home Depot and Lowe's and has ceded 10% market share to the two firms since 2000 to the current 30%.

Sears' peers
Sears' investors might be celebrating the sale of its prime properties, but can hardly fail to recognize just how badly it compares to its peers. Two of these are Macy's ( M -3.25% ) and Nordstrom ( JWN -1.80% ), which seem to be in the pink of health when compared to Sears.

Perhaps Macy's investors are wondering what's so positive about the company, especially after having missed on the operating line with a $0.72 actual EPS in the second-quarter against the expected $0.78. But despite this shortfall, there is a lot still going for Macy's. The apparel dealer has a very impressive growth track-record as you can see below.

FY 2014 2013 2012 2011 2010 Average
EPS 3.85 3.29 2.96 2 0.78  
Growth 17.02% 11.15% 48.00% 156.41%   58.15%

Source: msn.com financial data

The growth rate for the captured range averages an astounding 58.15%, which is unmatched in the retail industry. Its partnership with footwear company Finish Line, seems to be bearing fruit on the strength of strong footwear demand. Macy's is also seen as one of the companies that stand to benefit from J.C Penney's marketing missteps that have led to loss of market share for the firm. Moreover, many analysts believe that the stock still has a significant upside potential.

Nordstrom, Inc. has distinguished itself in the retail industry with its exemplary customer service and high employee wages ($19.8 per hour vs. the industry average of $12 an hour). Nordstrom was voted as one of the best company to work for in 2012. The company has been growing its revenue by more than 12% since 2010, and shows no signs of slowing down. The healthy growth rate has already surpassed what the company managed in the pre-recession years.

Nordstrom, Inc.  is currently on an expansion frenzy, and has recently opened several large stores across the country. One of the largest is the 35,000 square-foot Rack Location in California. California is one of Nordstrom's strongholds where it enjoys incredible customer loyalty. The pleasant Hill facility is located right at the epicenter of an affluent neighborhood where household incomes exceed $130,000. Nordstrom aims to double its Rack Stores to more than 230 by 2016.Analyst Zacks has a ''Hold rating'' on Nordstrom.

Conclusion
Although Sears' investors are optimistic about the prospects of continued sale of its extensive properties, the current share price might not accurately reflect their fair value, unless of course the Bakers Street report is to be believed. The business side of Sears continues to ail with no real signs the company will show a clean pair of heels to its core competitors anytime soon. Investors are best advised to take a more balanced perspective of the company.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

J. C. Penney Company, Inc. Stock Quote
J. C. Penney Company, Inc.
JCPN.Q
Macy's, Inc. Stock Quote
Macy's, Inc.
M
$26.80 (-3.25%) $0.90
Sears Holdings Corporation Stock Quote
Sears Holdings Corporation
SHLDQ
Nordstrom, Inc. Stock Quote
Nordstrom, Inc.
JWN
$20.19 (-1.80%) $0.37

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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