Sears: Don't Invest For Retail Alone

It's the same old story with Sears Holdings (SHLD). In fact, I feel like I'm just repeating myself a lot. However, I have long been positive on the stock, and it is one of Peridot's top five holdings, so rather than ignoring it just for the sake of not sounding repetitive, I will likely continue to share my views on the company and the stock's investment merit.

In case you missed it, Sears reported Q3 earnings of $1.27 per share and sales of $11.94 billion. The revenue number was at the high end of estimates, and the earnings number included investment income of 42 cents per share. Excluding one-time charges and investment income, earnings did miss consensus estimates, which caused the sell-off in the stock.

Comments on the quarter across Wall Street were very predictable. Same store sales were down, which is bad and must be turned around at some point. Earnings were up on cost cutting, but such moves can't be maintained forever. Most analysts are ignoring the investment income when looking at the quarterly results, because they are unrelated to operating activities of the main retailing business.

It is my view, however, that ignoring the investment income is a mistake for investors. If an investment in Sears stock was merely a bet on the retail operations, then I can understand not caring about profits derived from investing excess cash. However, a large piece of the investment thesis behind SHLD has been, and will continue to be, Eddie Lampert's ability to allocate excess capital in order to earn returns that far exceed those of the retail business. There is a reason he changed the name of the firm to Sears Holdings. It's a holding company. There is more than just retail here.

Investors who are in Sears merely for the retail operations should probably move on to something else. SHLD will continue to report declines in same store sales and grow profits via cost cutting, share repurchases, and investment income. This will ultimately lead to a tremendous increase in shareholder value.

If, however, you are like me and are investing in this stock for the entirety of the operation, then you should stay with it despite today's decline. Sears is a holding company and will continue to boost shareholder value via multiple ways. In fact, as the company finds new avenues for allocating capital, they will become less and less reliant on Sears and Kmart than they already are.

While this will draw criticism from many, especially retailing analysts, the end result will be a rising share price, which is really all that matters to me.

Full Disclosure: I own shares of Sears Holdings personally, and my clients do as well.

Related: Sears Holdings: A Hedge Fund Struggling With Declining Retail

Comments

[steve rifkin:]

Chad, why do you assume Sears Holdings will find good deals to invest in?

There is so much more money in hedge funds today (not to mention private equity). I dont see great deals as low hanging fruit anymore. Do you?

Lastly, and perhaps most importantly, do you believe Ed Lampert will give the best deals that he does find to Sears Holdings or to his other hedge funds?

Thank You,

Steve Rifkin

2006 Nov 17 02:39 PM

[Chad Brand:]

Hi Steve,

A couple thoughts come to mind.

As far as finding quality investment opportunities, I am of the belief that in most markets there are always undervalued investments. Sometimes they are harded to find than others, but they are there if one is willing to look. It is true that investment assets have risen dramatically, and there are more people looking for places to put money, but even if hedge funds did not exist, that money would have been invested through more traditional vehicles. I have no reason to believe that value investing will become less and less feasible due to the growth of the hedge fund industry.

As far as whether Lampert allocates his best investment ideas to his hedge fund, or to Sears Holdings, they are essentially one and the same. Why do I say that? Lampert's hedge fund has 75% of its assets in SHLD stock. This equates to 42% of the company. Lampert's personal wealth is also tied up in the hedge fund, as is the case with many hedge fund managers. Given this is the case, he has an incentive to use SHLD as his investment vehicle of choice when he finds good opportunities. After all, his money, as well as his clients' money, is mostly invested in SHLD stock.

2006 Nov 18 07:43 PM