Why I Bought Wal-Mart and Sold Sears

Over the past decade, there has been a significant divergence between Wal-Mart (WMT) Stores’ experience from a business perspective and the returns experienced by the company’s shareholders. In April, I wrote an article outlining Wal-Mart’s track record over the past ten years and the risks of overpaying for a strong growth record. There are numerous other examples of well known companies that have advanced significantly in terms of business results over the past decade while stockholders received little if any return.

New Position Initiated

A new position in Wal-Mart has been initiated based on a number of factors. Much of the case related to Wal-Mart’s business track record was made in my prior article so I will not repeat all of the factors here. However, a few factors related to this decision are discussed below. (View the full WMT chart at Wikinvest).

First, as my previous article outlined, Wal-Mart has proven its business model over a long period of time by demonstrating a remarkable ability to grow its top and bottom lines despite already being a very large enterprise ten years ago. During this time frame, store count nearly doubled, gross margins actually improved, and net profit margins remained relatively constant.

Wal-Mart has also made progress attracting middle class and upper-middle class customers who “traded down” to the retailer as consumer confidence plummeted over the past year. Many of these shoppers will not quickly abandon Wal-Mart when the economy recovers given that confidence will be shaky for some time to come and familiarity with the stores could build customer loyalty. Just as the Great Depression created a generation preoccupied with thrift, I anticipate that the current economic dislocation will lead to more appreciation for low prices in the coming years. As the low cost provider, Wal-Mart fills a need that will remain in demand.

Wal-Mart has been criticized recently by its decision to stop reporting monthly sales and sales forecasts. My view is that moving to quarterly reporting is a healthy development that will reduce investor fixation on ultra short term results and trends that can be influenced by numerous factors unrelated to the underlying economics of the business.

Although Wal-Mart’s valuation is now far more reasonable than typical valuations over the past decade, it should be noted that investors purchasing shares at current levels should be satisfied with returns correlating with business results rather than counting on a return to very high multiples of earnings.

Sears Holdings Shares Sold

To make room for Wal-Mart in the portfolio, profits were taken on shares of Sears Holdings (SHLD) after the recent advance in market price. While Sears Holdings is a retailer, given its operations of Sears stores in the United States and Canada as well as K-Mart stores, the investment case for Sears Holdings has been related to the value of its real estate assets rather than the value of its declining retail businesses. (View the full SHLD chart at Wikinvest).

Chairman Edward Lampert is attempting to save the retail operations in an attempt to minimize job losses and impacts to local communities served by Sears and K-Mart. However, both retailers are suffering long term declines in business and it is clear that Sears Holdings is unwilling to make dramatic investments in the retail operations.

Bruce Berkowitz of The Fairholme Fund was recently interviewed by Outstanding Investor Digest regarding his investment in Sears Holdings among other topics. Berkowitz conducted an analysis last summer of the property tax assessments for real estate owned by Sears Holdings and came up with a valuation of $80 to $90/share for the real estate alone.

While these valuations may hold up, it is worth noting that much of the real estate is held in mall locations that are experiencing a long term decline as consumers increasingly favor big box store formats. Given that assessments for 2008 were set prior to the recent economic turmoil impacting commercial real estate, it seems prudent to assume that the real estate valuation is quite a bit less than $80/share today. If one further concludes that the retail operations are in a long term runoff, Monday’s price of $61 for Sears Holdings appears to lack a sufficient margin of safety even if some upside remains.

Disclosure: The author purchased shares of Wal-Mart Stores Monday at an average price of $49.99 and sold Sears Holdings shares at an average price of $61.05. This article should not be considered a recommendation to buy or sell securities and readers should conduct their own due diligence prior to making any investment decisions. The author has no obligation to update this article in light of changing future circumstances or post an article prior to taking further actions in either security discussed.

Comments

[Noise Free ...:]

Wal-Mart is a great company in a tremendous competitive position. However, that doesn't make it a great investment. If the company's returns track its business results over the next ten years you might be in for a disappointment. Assuming a 10% sales growth means that WMT will sell 440 billion next year and over 1 Billion in ten years time. It's possible, of course, but it's difficult to add 40B in sales next year.

Sears on the other hand offers some interesting scenarios. One is the real estate another the liquidation and yet another the successful transformation of the company. The real estate is often in desirable locations (the last to decline in value and first to go back up); Target, Home Depot, and others would love to buy the best 300-400 stores from Sears. In fact, as Ackman pointed out yesterday, this is one of the reasons he wanted to free up capital for Target.

The less desirable locations are also sometimes rented at well below market leases. Inventory reductions from store closures or sales turns into cash which can either be reinvested in the business or returned to shareholders.

While an investment in Sears is not as compelling as it was when the company was trading in the high 20's per share, I believe it will trump WMT over the next 5-10 years.

Time will tell, thanks for the post.

Jun 02 08:48 AM

[Noise Free ...:]

Sorry that should read $1 Trillion in tens years time, not $1 Billion.

Jun 02 08:51 AM

[madmilker:]

People in America need to realize jus what got America in this shape…”cheap” yes so-call cheap items from a foreign land.

quote*Wal-Mart firmly believes in local procurement. We recognize that by purchasing quality products, we can generate more job opportunities, support local manufacturing and boost economic development. Over 95% of the merchandise in our stores in China is sourced locally. We have established partnerships with nearly 20,000 suppliers in China. *end quote!

Now! if there be 182 country’s making items for the world to buy and they have only 5% of the pie in China…duh! This company makes the nice people of China support their currency(yuan) by keeping it in their country working for the people there…. but with the “yuan” going up in value and the US dollar going down…all the foreign items that the American consumer buys thinking it is cheap has went up in price.

People…its all about the currency and to keep a currency strong you got to keep it floating around the country you live in so it can work for you. For the past 12 years all them US dollars are being shipped overseas to a foreign bank and with the American worker not making anything for the foreigner to buy the “we the people” have to turn to the “second” largest employer in America(Uncle Sam) to sell “we the people” debt in order to get all them dollars back!

50 years ago a foreigner would had given their left nut for a US dollar or a Hershey’s chocolate bar and today the same foreigner has got Uncle Sam and the American consumer by both all the while Hershey is moving the chocolate factory to Mexico. Wake up! America and think “MADE IN AMERICA.”

quote*"Considering that there are over 30,000 ships at sea this morning," writes James Carlton, director of the Williams College-Mystic Seaport Maritime Studies Program, in an e-mail, "the total number of organisms and species in this global 'bioflow' on the morning your readers read your piece could be staggering - billions of individuals, and thousands of species."

Indeed, scientists have long considered ballast water the primary way invasive aquatic organisms are introduced. From the zebra mussel's arrival in the Great Lakes, to an American jellyfish severely disrupting Black Sea fisheries, the potential costs of accidental introduction of a species to new homes can be tremendous. Aquatic invasives cost the US $9 billion yearly, according to estimates by David Pimentel, professor emeritus of ecology and evolutionary biology at Cornell University in Ithaca, N.Y. Zebra and quagga mussels (a cousin to the zebra) alone cost the $1 billion annually.*end quote!

tat is $9 billion a year in hidden taxes to all Americans...
cheap ain't chic and it cost America............jobs!

quote*Now let us look at Wal-Mart again; you buy a product there, 6% goes to the employees, 10-18% is profit to the company, 25% goes to other costs and 50% goes to re-stock or the cost of goods sold. Of the 50% about 20-25% goes to China, a guess, but you get the point. Now then, how long will it take at 433 Billion dollars at year for China to have all of our money, leaving no money flow for us to circulate? At a 17 Trillion dollar economy less than 40-years minus the 1/6 they buy from us. Some say that if we keep putting money into our economy, it would take forever, but if we do not then eventually all the money flow will go. If China buys our debt then eventually they own us, no need to worry about a war, they are buying America, due in part to our own mismanaged trade, so whose fault is that? Not necessarily China, as they are doing what's in the best interests, and we should make sure that trade is not only free, but fair too.*end quote!

www.worldthinktank.net...

"After bragging in the late 1990s about budget surpluses, when in fact the general government was in deficit (not surplus) despite the highest tax revenue share of the economy in peace-time history, we know they were claiming trust fund surpluses as their own. They were understating their claimed deficits by mixing in surpluses of trust funds."

mwhodges.home.att.net/...

Jun 02 09:00 AM

[Ravi Nagarajan:]

I agree that Sears offers some interesting scenarios. IF Lampert can turn around the retail operations and make Sears and K Mart successful, then there is a heck of alot of upside left in these shares. There is no doubt about that. However, I purchased Sears based on the commercial real estate liquidation scenario, not the retail play, and I believe that the recent trends for both Sears and KMart are quite poor. Lampert is trying to do his best to save the retail ops but he is (correctly) not willing to throw cash at the situation endlessly. Advertising expenses, for example, are down.

My view is that investing in Sears as a retail play is speculative under the circumstances.

Given that the real estate liquidation scenario has only limited further upside, I sold my shares since that was the original reason for my purchase. To hold the shares as a retail play would be to change my initial rationale for the purchase which, in my opinion, would be speculative.

Lampert could be the next Buffett and I may feel very silly in a few years for selling.


> Sears on the other hand offers some interesting scenarios. One is
> the real estate another the liquidation and yet another the successful
> transformation of the company. The real estate is often in desirable
> locations (the last to decline in value and first to go back up);
> Target, Home Depot, and others would love to buy the best 300-400
> stores from Sears.

Jun 02 09:01 AM

[dingojoe:]

Sears/KMart is dead as a retailer specifically because of the real estate. Eddie doesn't relocate stores to take advantage of changing shopping patterns (unlike every other retailer) thus he has a growing portfolio of stores that are dying on the vine. Numerous Sears stores are operating in malls that have shut down. How long can the Sears stores remain open? Kmart has largely been reduced to backwater locations and is steadily being shut down. Eddie did take one crack at creating a freestanding Sears format with the Sears Grand/Essentials format, but those are being shut down now. I'm sure Sears does have some RE with value, but I'm guessing that the number is closer to 100 than 300-400.

Ultimately we will find out the liquidation value of SHLD because that day is approaching.

Jun 02 01:53 PM

[Ravi Nagarajan:]

I think that Lampert is trying to do for Sears and K Mart what Buffett did for the textile mills when he purchased Berkshire Hathaway. In both cases, these existing businesses were in long term decline yet any immediate liquidation/shut down would have had catastrophic impacts on society. To the extent that the businesses are not consuming cash flow, it is admirable behavior to attempt to mitigate impacts in this manner. Now, Buffett wasn't acting as a philanthropist with Berkshire in the 60s and Lampert isn't doing so now with Sears Holdings. I think that Buffett's reputation built over many decades as not being a "musical chairs" operator of business has resulted in many acquisitions of family run enterprises for Berkshire in recent years - purchases that could never have been done if Buffett was viewed as a short term liquidator.

Lampert may or may not be trying to emulate Buffett, and the entire comparison may be false. However, I strongly suspect that eventually the real estate value will be realized in some form and that the capital required to make Sears and K Mart real competitors for the likes of Target and Wal-Mart will not be forthcoming. It would require too much consumption of cash and is too speculative for someone like Lampert to do this - he'll run the stores until they start consuming cash and then close them.

FWIW, I am no market timer! SHLD has advanced $5/share beyond my sale price yesterday! Time will tell if my move was correct or not. I do feel confident that with WMT I have retail exposure to an enduring business model which is what I wanted to accomplish by my move rather than maintaining what is becomming a more speculative real estate play with SHLD.


On Jun 02 01:53 PM dingojoe wrote:

> Sears/KMart is dead as a retailer specifically because of the real
> estate. Eddie doesn't relocate stores to take advantage of changing
> shopping patterns (unlike every other retailer) thus he has a growing
> portfolio of stores that are dying on the vine. Numerous Sears stores
> are operating in malls that have shut down. How long can the Sears
> stores remain open? Kmart has largely been reduced to backwater
> locations and is steadily being shut down. Eddie did take one crack
> at creating a freestanding Sears format with the Sears Grand/Essentials
> format, but those are being shut down now. I'm sure Sears does
> have some RE with value, but I'm guessing that the number is closer
> to 100 than 300-400.
>
> Ultimately we will find out the liquidation value of SHLD because
> that day is approaching.

Jun 02 02:10 PM

[Stone Fox C...:]

Seriously doubt the tax value of the real estate matches the real value. Berkowitz was simply making the point of how cheap the stock is these days. Both he and Lampert were buying at much higher levels last year and they didn't buy with the goal of making 10%. When Lampert was buying the $150s last year, he clearly saw the value much higher then todays close near $70. Even this close barely values the company above its net cash position (cash + inventory - debt) so SHLDs enterprise value is virtually nill leaving value in real estate as all upside. Not to mention other assets.

Jun 02 06:08 PM

[Dan Braem:]

Ravi - the Lampert / Buffett comparisons are interesting...not happening yet but time will tell. Big difference in my opinion is that Lampert spent billions on Sears stock via buybacks and unfortunately destroyed billions in shareholder capital.

Buffett never did a buyback and always attempts to allocate capital to the best possible source.

For the prophecy to be completed, Lampert will need to allocate the cash flow to other businesses - I don't think that will happen.

A more interesting scenario would be a Autozone / Sears Merger.

Jun 03 12:14 AM

[Ravi Nagarajan:]

According to reports of the Sears annual meeting, Lampert deflected questions regarding redeployment of capital and focused on the retail operations. The situation won't be exactly the same but there are some similarities in terms of running down a business that may be in an irreversible long term decline.

You're right about shareholder value being destroyed with the buybacks at much higher share prices.


> For the prophecy to be completed, Lampert will need to allocate the
> cash flow to other businesses - I don't think that will happen.
>
>

Jun 03 08:32 AM

[Marsden:]

Sears is still in business? Where? What do they sell?

Who buys it?

Jun 03 08:49 AM

[Ravi Nagarajan:]

Craftsman and Kenmore are quality brands but I rarely shop at Sears anymore. Lands End is the exception - solid values there. FWIW, Craftsman makes great garden tractors at good prices ...


On Jun 03 08:49 AM Marsden wrote:

> Sears is still in business? Where? What do they sell?
>
> Who buys it?

Jun 03 09:20 AM

[Marsden:]

Alas, I used to swear by both Craftsman *and* Kenmore. But lately I'm finding the names are stuck to the cheapest crap that Sears execs can (out)source, and the durability which was once a byword of those brands is no more.

Symptomatic of the current American variety of capitalism is to endeavor to sell the lowest-possible-quality product for the highest-possible price. Good for the bottom line, for a few quarters anyway.

Jun 05 01:34 AM