Will Eddie Lampert's Next Big Purchase Be in Retail?

by: NakedValue

Not long ago, many people wanted to anoint Eddie Lampert as the next Warren Buffett. His venture into retail through a brilliant Kmart stake and subsequent Sears (NASDAQ:SHLD) takeover demonstrated both his investing prowess and his willingness to deviate from Buffett’s investing style. Since then, Lampert has shown a continued willingness to invest in retail names, most notably with his inquiry into J Crew Group (JCG) and his large stake in Gap Stores (NYSE:GPS). This willingness is likely driven by the cheapness of retail stocks and cost cutting opportunities through better use of store space.

Lampert may be drawn to companies with earning potential and a sizeable store footprint. Here is a list of companies that could be Eddie Lampert’s next big purchase:

This mall-based retailer of casual teenage apparel has the type of high returns, low price/earnings that will grab Lampert’s attention. With 2011 projected earnings between $2.20 to $2.40, Aeropostale trades at a forward P/E of 10.50 and features a return on equity of more than 50%. While the company is nears the 1,000 store mark, it still has growth potential through the P.S. From Aeropostale brand which has grown to 47 stores since it was launched in 2009. Aeropostale’s cheap valuation may give Lampert the margin of safety he needs. There are possible synergies between Sears and the youth oriented Aeropostale, but even if these synergies are not realized, Aeropostale still stands on its own as a reasonably priced investment.

Aeropostale’s cheap valuation has attracted attention. They recently hired Barclays (NYSE:BCS) to advise them on a takeover defense. While this signals that they won’t sell cheaply, this would not preclude Lampert from initiating a passive investment.

This is another youth oriented mall based retailer that offers a Sears synergistic opportunities at a reasonable price. With forward P/E of 13.25 and trailing EV/EBITDA of 4.91, even if this company does not revitalize Sears’ youth retail and online sales, they still have a good retail brand at a reasonable price.

The most important difference between American Eagle and Aeropostale may be that American Eagle’s CEO, Jim O’Donnell is retiring, possibly putting the company in play.

Lampert has become a master of cost cutting, operational optimization and creative approaches. This high risk opportunity could offer home run returns if Lampert can successfully utilize the opportunities at Barnes & Noble.

The Borders’ bankruptcy has created convenient headlines, but while the brick and mortar book industry is in decline, it is far from dead. Even Borders recently announced that after closing around a third of their stores that they intend to emerge from bankruptcy this summer. Despite the negative headlines and sentiment, Barnes & Noble generated surprisingly consistent sales per store. In 2004, there were 647 Barnes & Noble stores with each one producing around $5.9 million in sales. In fiscal 2010, this figure was $6.0 million. While store sales are down from the 2005 peak of $6.5 million per store, these numbers are stronger than expected from recent headlines.

Books-A-Million is a good example of what a standalone, brick and mortar bookstore can achieve in the current environment. Barnes & Noble's national reach, scale and well received Nook eBook reader should all be advantages rather than hindrances. Lampert is a no nonsense investor who demands return on capital, would love Barnes & Noble's core high cash flow business and flexible lease schedule, unlike Borders which was largely driven to bankruptcy because more than 70% of their store leases expired after 2017.

Lampert is obsessed with technology and new avenues for reaching customers. This is evidenced by Sears Holding’s Craftsman Experience venture. Lampert could view a Barnes & Noble acquisition as a cheap way to enter the eBook reader/tablet market with the more than competent Nook reader. With a 25% percent market share in the eBook market, Lampert find this growing market attractive especially since Sears could significantly expand the Nook’s selling channels.

Finally, key to Barnes & Noble’s potential is the realization that the company is not bound to books. While the consistent sales per store data show that the company still has a strong customer following, the company has the flexibility to sell other products from gifts to children’s items to educational products.

This company is not cheap based on traditional valuation measures. The company has a forward P/E of 20.26, a PEG ratio of 1.25 and a trailing EV/EBITDA of 6.88. The company’s true investment potential comes on two fronts. First, it’s return on assets is 6.46%, close to half of Starbuck’s (NASDAQ:SBUX) return on assets of 13.7%. Lampert has been very successful maximizing return on capital. Any convergence with Starbuck’s profitability could significantly increase profitability. There would be potential for significant growth if Lampert introduced Caribou Coffee locations to Sears stores. Caribou currently has 534 locations compared to the roughly 4,000 locations under Sears Holdings.

This is a cheap company with synergistic potential. With a forward P/E of 7.01, a PEG ratio of 0.60 and a trailing EV/EBITDA of 4.04, the low valuation gives Lampert a high margin of safety. With 6,450 stores, this gives Lampert an extensive store footprint to work with. In addition, this gives Sears Holding exposure to a niche clientele (young male game enthusiasts). If there are able to selectively integrate the GameStop business into even a portion of their 4,000 stores, this company could offer significant leverage to the upside.

Lampert’s hedge fund ESL Partners recently added a stake in H&R Block. While it’s unclear what the fund’s true exposure or intention is since hedge funds are only required to report their long US stock positions, H&R Block has the hallmarks of a stock that would interest Lampert. The forward P/E is 10.29, the PEG ratio is 1.19 and the trailing EV/EBITDA is 5.65. The company could offer significant synergies if Lampert were able to add H&R Block locations in Sears stores the way Jackson Hewitt has integrated Jackson Hewitt locations.

RadioShack’s forward P/E is 7.65 and it’s trailing EV/EBITDA is 3.50. Despite the fact that the company is despised by the market and faces pressures from Amazon and Best Buy’s rollout of a smaller retail format, the RadioShack has continued to produce high returns on assets. During the last twelve months, the company generated returns on assets of 10%. With almost 4,500 company owned stores, RadioShack’s format Sears a different opportunity from the other companies. RadioShack gives Sears a huge additional network to showcase their proprietary brands, most notably Kenmore and Craftsman. These brands were central to Lampert’s interest in Sears and this would be a viable way to unlock some of their value.

Disclosure: I am long BKS.