Think Sears Is On Sale And Cheap? Think Again

Jan. 5.12 | About: Sears Holdings (SHLD)

If only the price of Craftsman tools fell as fast. Sears' stock (NASDAQ:SHLD) has been in a practical free fall for the last couple of months. The recent gap down toward the end of December may have been looked at as the capitulation of investors throwing in the metaphorical white towel.

A closer examination demonstrates Sears has plenty of room to keep falling. The shares are falling so fast the 60-day moving average is almost twice the current trading price and may end up twice as high before today's trading is finished. Both the 90 day and 200 day moving average are higher than the 60 and are now trending lower. For trend followers the chart displays very little encouraging news for investors and it's no wonder so many are shorting the stock.

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Using some simple behind the envelope math, we can see that if we remove goodwill and intangibles shareholder equity drops from $7.7 billion down to $3.22 billion. Next if we remove 20% from plant and equipment of $7 billion ($1.4 billion) we are down to equity of $1.82 billion. Subtract 20% from the valuation of inventory ($2.2 billion) and we have negative shareholder equity. Adding in the negative cash flow we can see that while Sears is down dramatically over the last few months it is still nowhere near what many would call "value priced." Sears may have a dead cat bounce (which I write about later), but that should be viewed as an opportunity to short.

Here is a look at the fiscal year revenue.

Holy Short Seller Batman! Granted the float size of 37.1 million shares is relatively small compared to the total shares outstanding of about 107 million shares, but the short interest is over 44% based on the last reporting date of December 15th 2011. Considering the price movement since December 15th, and it would be reasonable to believe every other share on the market today is currently loaned out to "Sammy the Short Seller." Sammy is a smart guy, and in fact I write often that investors should pay close attention to short sellers as they are the smart money. Sammy doesn't always get it right, but he gets it right so often you will really miss out if you discount him.

The total short interest number of shares for SHLD.

The number of days to cover short interest based on average daily trading volume for SHLD.

Sears may be worth less than the tools in my garage even after subtracting the ones I borrowed from the neighbor. Looking at the latest quarter ending October 31, 2011, let's compare a few financial statements to see just how well Sears is performing compared to peers. I picked (NYSE:WMT), Target (NYSE:TGT) and Best Buy (NYSE:BBY) for peers. It's about as close as you can get when you consider Kmart is part of the equation and poor electronics sales have been cited as part of the problems facing Sears.

All three peers have greater revenue for the last fiscal reporting quarter. We can see Best buy is having its own problems as it doesn't seem able to profit from sales as much as Sears.

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No assets, but how about income? The last quarter Sears posted earnings and not losses was four quarters ago. Reviewing the yearly results doesn't paint a much brighter picture. Fiscal year ending January 2011 reported half the profits of the same period 2010, but much higher than the ultra-low gains of 2009. After the losses in all three of this year's reporting periods so far, and the reported slow holiday season, it's all but a sure bet this year is going to get marked as a loser.

All the tools you could possibly want and no budget to use them with. While the reported numbers paint a picture so ugly even a mom would throw it away, it gets worse. Looking forward, Sears is going to have to play a game of catch-up and do so with borrowed cash.

Even with reports of 100-plus Sears and Kmart stores closing due to poor performance, it will not nearly be enough. Sears will have to spend money to update the stores they do intend to keep open. This likely will not be cheap as they haven't exactly kept up with the Jones lately. Mr. Boire, whom Sears just hired to lead the renewal of the Sears shopping experience, will have his hands more than full. After years of neglect it will take some unraveling to clean house. So far Mr. Boire will have at least 79 less stores to worry about as Sears has released the locations of most closings.

Wal-Mart, on the other hand is making money in this market. Unlike Sears, Wal-Mart pays a fat dividend of 2.4%. Sales this year are approaching half a trillion dollars and Wal-Mart is still growing. Even same store year-over-year numbers are turning around and rewarding investors. With such a low PE Ratio of 12.5 I believe Wal-Mart offers a much better risk to reward ratio compared to Sears. The implied volatility for such a large and stable company is not bad either. The March 2012 $55 strike price put options can be sold for about $0.69 each. If Wal-Mart stock does move lower, the cost basis would be $54.31 a share. Quite a bit less than the current trading value of about $59 a share.

Target is another example of a retailer that is retailing correctly. Target has made money the last four quarters, and for the last three years (as far back as I went for this story). Target has flatten out somewhat in fiscal year 2011 compared to 2010 which I consider a win in today's economic environment. Clearly Target is eating off of what used to be Sears' plate.

Turning our attention and direction we can see what another troubled retailer looks like. Best Buy has recently been downgraded and the stock lingers near the 52-week low. Also, 60, 90, and 200 day moving averages are above the price and trending lower. For trend followers this can mean to hold steady with shorts in place. With that in mind it's no surprise to see the short interest almost hitting 10% of the float. I am not a big fan of shopping, but I do like Best Buy stores. At least where I live the staff is friendly and they are quick to help. Given a choice, though, saving money online or buying retail I will usually pick online. It appears I am not alone as sales migrate from retail to the web accelerated by the use of smart pricing smart phones.

Technically for me, Sears is setting up for a bounce in price either tomorrow or Monday. I will likely go long Sears for the bounce if the set-up completes. Afterwards, I will be looking to short the move higher for a longer term investment. The premium for Sears stock options is sky high. This is no surprise considering the price is so weak. The high option premium may largely be mitigated by looking at back month options and writing a put spread. For example buying the March $25s and selling the March $20 can result is about a double if Sears falls below $21ish. Another method and one that I prefer is to write a bear call spread. In this case I will write (sell) a March $30 call for about $3 and sell a March $40 for about $1 (again based on a move higher first). I have protection if Sears reverses and moves higher but I also get part of the time decay premium in my favor.

If you want exposure to retail, avoid Best Buy, and short Sears, especially the rich call option premium. Wal-Mart may be big, but they still have room to grow and you will likely be able to sleep at night with greater comfort.

Do you have a company you want me to review? Do you share or not share my thoughts? Let me know in the comments below.

I use a proprietary blend of technical analysis, financial crowd behavior and fundamentals in my short-term trades, and while not totally the same in longer swing trades to investments, the concepts used are similar. You may want to use this article as a starting point of your own research with your financial planner.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in SHLD over the next 72 hours.

Additional disclosure: I may short SHLD options within the next 72 hours.