Sears Holdings (NASDAQ:SHLD) gained a stunning 21.3% by the end of trading activity on February 23 off the preceding day. The gains resulted following the company's turnaround plan announcement that averted investor fears about nearing bankruptcy. Against this backdrop, I contrast the struggling retailer with the world's most successful retailer ever, Wal-Mart (NYSE:WMT). Based on my review of the fundamentals and DCF model, I find strong upside for Wal-Mart and recommend Sears for those willing to swallow the risk.
From a multiples perspective, Wal-Mart is cheap. It trades at a respective 13.2x and 12x past and forward earnings, with a dividend yield of 2.5%. The retailer is valued at only 92% of its historical 5-year average PE multiple. Sears, on the other hand, has been bleeding billions upon billions, and is expected to do so over the next three years.
In a letter to shareholders, Sears' Chairman addressed weak results by announcing a turnaround plan:
"Our poor financial results in 2011, culminating in a very poor fourth quarter, underscore the need to accelerate the transformation of Sears Holdings. While some may claim that these results are a continuation of a trend, I believe that they are an anomaly after three years of relatively stable EBITDA performance ($1.1-$1.4 billion for US Domestic operations), albeit at a level well below our peak performance in 2006 ($3.2 billion in EBITDA for US Domestic operations). We own 95% of Sears Canada, which also experienced very poor results, and included a change in management in mid-year…
As I have explained in the past, the Board of Directors and I look at and evaluate Sears Holdings as a portfolio of businesses, with different market positions, strengths and opportunities. The ability to successfully transform the disparate businesses we have in the Sears Holdings portfolio under a single management structure has proven very difficult. While it may be possible to complete the transformation in the current structure, your Board of Directors is unwilling to continue on the current course across the entire portfolio".
The company intends to separate management across its businesses. It will sell 11 stores, cut inventories, and spin off Sears Hometown and Outlet to shareholders. This effort will boost the balance sheet by around $1B, demonstrating better liquidity than what the market acknowledged.
While uncertainty in cash flow generation and low single-digit margins give me reason to pause over the firm's ability to meet financing obligations, Sears, in my view, is unlikely to default in the near-term. The retailer has a strong brand and plenty of opportunities to sell assets, lease holdings, and restructure, as it proved on Thursday. Having failed to grow revenues since the merger with Kmart, the bar has been set low for the firm, which will possibly allow for strong risk-adjusted returns.
Consensus estimates for Sears' EPS forecast that it will decline by 9% to a loss of $5.11 in 2013, decline by 14.5% in 2015, and then improve by 32.5% in 2015. Fourth-quarter results featured a staggering loss and, according to T1 Banker, the firm is rated around a "sell". The retailer, however, has been heavily discounted from financial concerns, and thus any signs of momentum will drive significant risk-adjusted returns, as evidenced by its beta of 1.9. An improving economy will further generate appreciation.
While Sears is mired in bankruptcy fears, Wal-Mart is in an exactly opposite position. This mature retailer delivered impressive fourth-quarter results, with a diluted EPS of $1.51 and a comp sales gain of 1.5%. Wal-Mart is hedging against domestic stagnation by penetration in international markets where it delivered $35.5B in sales for the recent quarter. Wal-Mart International - already one of the top three biggest global retailers - is improving scale through acquisitions, such as Massmart and Netto. Management is additionally committed to returning free cash flow to shareholders - $11.3B for FY2012.
Consensus estimates for Wal-Mart's EPS forecast that it will grow by 8.2% to $4.86 in 2013, and then by 9.5% and 8.6% in the following two years. Modeling a 3-year CAGR of 8.8% for EPS, and then discounting backwards by a WACC of 9%, yields a fair value figure of $73.89, implying 26.2% upside.