Sears Holdings: A Baby Berkshire in the Making?

Last semester my history teacher and I used to stay after class and discuss the market. She asked me, about one month ago, what stock I like right now, and I mentioned Sears. Her reaction was not one that I had hoped for.

It struck me right away that she was not up to date with what was going on at Sears Holdings (SHLD). She had the picture of a struggling American icon. I had the vision of a baby Berkshire Hathaway (BRK.A).

Sears Holdings was created when Kmart Holding Corp. acquired Sears Roebuck, thus creating Sears Holdings Corp. Both Kmart and Sears have been around since the late 19th century and both struggled in the latter half of the 20th century as Wal-Mart (WMT) expanded.

Below is the company profile from Yahoo Finance:

Sears Holdings Corporation, through its subsidiaries, operates as a retailer in the United States and Canada. The company operates through three segments: Kmart, Sears Domestic, and Sears Canada. The Kmart segment operates stores that offer general merchandise, including products sold under labels, such as Jaclyn Smith, Joe Boxer, and Martha Stewart Everyday, as well as in-store pharmacies. The Sears Domestic segment operates full-line stores that offer an array of products, including home appliances, consumer electronics, tools, fitness, and lawn and garden equipment; automotive services and products, such as tires and batteries; and home fashion products, as well as apparel, footwear, health, beauty, pantry, household products, and toys. This segment also operates specialty stores, which provide casual clothing, accessories, and footwear for men, women, and children, as well as home products and soft luggage. In addition, this segment provides product repair services for home appliances, lawn and garden equipment, consumer electronics, floorcare products, and heating and cooling systems. This segment also offers its products through apparel Web sites, catalog mailings, international businesses, and end retail stores. The Sears Canada segment operates retail stores, which offer apparel and other softlines. The company also offers its products through its Web sites. As of May 18, 2006, the company operated 3,900 full-line and specialty retail stores in the United States and Canada. Sears Holdings was founded in 1899 is headquartered in Hoffman Estates, Illinois.

To see why I think Sears Holdings will become the next Berkshire Hathaway, let's look at the man running the show, Edward Lampert. He graduated from Yale University in 1984 with a BA in economics. At Yale he was a member of the Skulls and Bones society and served as an interim at Goldman Sachs (GS).

At age 25, Edward Lampert started his own hedge fund, ESL Investments. Using an investment style similar to Warren Buffett's, ESL Investments has averaged returns of 29% per year. ESL Investments became Kmart’s major shareholder when it built up a huge position at a time the company was going through bankruptcy and shares were depressed.

When ESL Investments became the largest shareholder, Edward Lampert became chairman of Kmart. He has also been credited for being the architect of the Kmart-Sears merger and has been called a genius by Marty Whitman of Third Avenue Management.

Let’s face it, Sears the retail operation is a mess. Same store sales continue to drop each quarter, but are slowly improving due to restructuring. In its latest 10-Q, management continues to reduce expenses, increase margins, cut inventory, and introduce Kmart brands (Martha Stewart Living) to Sears and vice versa. But the key point I’m trying to drive is the investments Edward Lampert is making.

Investment income accounted for 101 million of the company’s 327 million net income. This number continues to increase each quarter due to Sears Holdings producing cash flow from sales of intellectual property and tax breaks.

When I mentioned the company to my history teacher, it sold around $175 and is now selling at $168, creating a buying opportunity for those interested. This is a perfect long term stock, as long as Edward Lampert continues to invest cash flow and improves the operation of the core business. I won't put a price tag on this puppy but for the sake of it let's say $110,000..

Disclaimer: I do not own shares of SHLD

Related: The Next Berkshire Hathaway?

SHLD 1 yr chart

Comments

[DericTeasley]

I read the Message from the Chairman shareholders report for SHLD. While the bull case is compelling there were a couple of things regarding Sears liabilities that gives this more risk than one would initially want to have.
1. Credit rating. SHLD believes that it should have a better credit rating than it does. Given its cash position and net debt, it believes its cost of capital should be less. The risk is that you have to convince the credit raters that you are in a better position which is a very tough task.
2. SHLD's pension liability. There were a couple of assumptions that were in here that once again are out of the control of SHLD and relies on regulators or Congress to do the right thing with regards to pension reform. The crux of the argument has two faults, one is the belief that lower interest rates increase the liability obligation and higher interest rates lowers the obligation. I personally believe that interest rates will begin to go down before they go up. The second is that a responsible company like SHLD is having its pension insurance premiums rise due to the ineptitude of many other companies and SHLD feels that this is ripe for review so as to make pension insurance rely more on the risk of the company as opposed to the risk of everyone under defined pension arrangements. Well I think we all know that when it comes to Congress, things that should happen and things that do happen don't necessarily go hand in hand.
Like most arguments for the bull case of SHLD comes down to "Do you believe in Eddie Lampert, or not?".

[Malkiel]

To balance off Deric and Alexes' analysis, let me point out that one of the big assets Sears supposedly had that made it a ripe vehicle for Lampert's magic is a big inventory of real estate and leases from Sears stores, making the stores a cash cow for the new holding shell as they are closed and sold.

One problem I see with using Sears as the sacrificial caterpillar for a new wasp is whether the shareholder base is on board with the transformation. If they believe they are invested long-term in a retailer, and have sentimental ties to that image, they may resist Lampert at the point where the original Sears stores need to be shed from the holding company.

I'm also curious as to whether Goldman Sach (GS) is also working that "next Berkshire Hathaway" karma--will we see GS and SHLD shares at $10,000 by 2017? Stay tuned.

Cramer, by the way, is way high on SHLD and suggests even his small-pockets followers buy a share or two ahead of any of the small stuff he talks about on "Mad Money"...

[Alex Garcia]

Thanks for reading the article guys always appreciate your views as well. Management has mentioned that they plan to run less sales events to save cuts. I would like to see numbers on how much they actually save and how foot traffic is WITHOUT the events. By the way has anyone seen the article about Edward Lampert being kidnapped? again thanks for actually taking time to read my work.

-Alex
wslounge.com