Sears Holdings (SHLD) has gone on an amazing run since its low of $29 in early January. On Friday, March 9th, it surpassed $80, for a 176% gain in only two months. With reports of drastic changes by the company, a $170 million investment by Eddie Lampert, a trending better economy, a higher stock market, and a big short squeeze, it makes sense for the stock to have great, consistent momentum. However, all the good news for the Sears bulls has come to an end, and when all that's left are fundamentals, the momentum will reverse course.
In February 2011, Edward Lampert's Chairman's Letter to SHLD shareholders said:
"2010 was another challenging year for Sears Holdings. Our financial results remain at unacceptable levels, and we are working to drive better performance in both the short and long term."
However, 2011 turned out to be financially much worse for Sears than 2010. One can only guess how bad 2012 will be.
In January 2012, Sears announced a horrible holiday season. It lost $2.4 billion in the 4th quarter 2011, its biggest loss in the history of the company. This is after reporting negative income in the last 5 out of 6 quarters. Its only winning quarter in the last six was the previous year's Christmas season where it booked a $382 million gain in the 4th quarter 2010. That is what put the stock at its low of $29. Adjusted EBITDA for fiscal 2011 was $277 million. This puts the current share price at a whopping 31x EBITDA.
Sears management apologized for such a lousy performance, and announced a gigantic turnaround. This includes:
- The closing of 100-120 Sears and Kmart stores to generate cash and cut costs.
- Investing heavily in technology to make operations more efficient. In January, the company equipped workers with 5000 iPads and 11,000 iPad touches for better inventory tracking and learning more about customers.
- Getting rid of several executives and hiring former Brookstone CEO Ron Boire as chief merchandising officer.
- The spinning off of their hardware and appliance products to smaller stores.
However, before Sears investors all start holding hands and singing "Kumbaya", let's analyze the ramifications of these new decisions.
- Usually, the worst time to sell stores is when the company is suffering. This is for two reasons: First, when a company is desperate and needs to unload stores quickly, buyers will take advantage of this and pay less than the stores are worth. And second, if the company is having trouble getting customers to go to that location, a buyer would be concerned that customers still wouldn't come after the store was sold. Perhaps there is something wrong with the store itself or its location. So Sears will find itself either selling unprofitable stores for less than market value, or selling profitable stores and thus losing profits. The company is selling profitable and unprofitable stores.
- Lampert has run Sears and Kmart stores for years under the philosophy of being frugal. Having cheap products, cheap technology, cheap renovation, cheap employees and frugal customers. So now, all of a sudden, Sears is going to start drastically throwing money on improvements? Is that the magic pill that will suddenly make everything better? The market certainly appears to think so. If that's the case, why didn't Lampert start doing that years ago? One could make the case that it's a new era of retail that demands more spending. If that's correct, it could still take years for Sears to figure this out. Why would investors think that Sears will become an instant success once money is thrown at the problem?
- Sears is letting go of old executives and bringing in new ones. This also costs money in severance fees, signing bonuses, as well as getting the new executives acclimated into the Sears culture.
- The spinoffs could be a success because its hardware and appliance segments have done well and might do better on their own. These segments include the famous Kenmore, Craftsman, and Diehard brands that Sears owns. Sears' management believes it was sometimes inconvenient for hardware buyers to find a specific piece of hardware or appliance in Sears huge outlet stores. An addition of these specialized stores would be easier for some buyers to find what they're looking for and also sometimes be a closer distance away. Even though Sears could make $500 million in the spinoff deal, there's no guarantee and it also will take away their hardware revenues, which would downsize the company further.
Sears' share price is now back to where it was before it lost $3 billion in 2011. It's as if investors thought that Sears management was asleep for the entire year, and now all of a sudden is drinking Red Bull and is on its A game. How do we know management wasn't on its A game last year but just had a tough logistical situation? If that's the case, then they can throw hundreds of millions of dollars at the problem and just make earnings worse, not better.
Now that the stock market has reached a high, and all the good news and announced changes for Sears has been absorbed, its momentum is bound to slow down. All the smart money has already invested in the company, starting with Ed Lampert in the $30s. At this price, it's primarily the momentum traders and dumb money that's jumping on board. No analyst would rate it a buy here. I doubt even Lampert or Berkowitz, Sears biggest holders, would recommend buying it here. After a stock has been shooting up like a rocket due to momentum and a huge short squeeze, when it cools off it inevitably reverses direction. It won't go back up until the fundamentals kick in. Right now, there's hope, but Sears is far from proving itself.
I think the best way to make money on the Sears pullback is to short in the money calls. That way you don't have to pay the high borrowing fees to short the stock or the incredibly high premiums that SHLD puts have.
I don't believe the inevitable pullback will be as fierce as some analysts claim. This is because the economy, as well as real estate, is showing signs of coming back, and many investors still will cling to the hopes that Sears' turnaround will be successful. But the fear that Sears' comeback won't be successful will also prevent the stock from going too high. My prediction is Sears will pullback in the next month or two to somewhere in the range between $60 and $70. This is if the stock market will take a break from its rally. If it doesn't, it's possible Sears could keep going up, but it still might pull back anyways.
The Bullish Thesis
I've often found, especially with large cap stocks, that the market is smarter than the analysts or talking heads. There could be many bullish things going on with Sears that the general investing public doesn't see. Here are three examples:
- The former management was a mess, and now that many executives have been replaced, it's a much more competent organization that's now on the right track.
- Upon investigation from consumer analysts, Sears has shown signs of sales increases in the past couple months that haven't been reported yet.
- Commercial real estate is worth a lot more than expected, and Sears is getting great returns for its stores that it's selling. According to the Q3 2011 balance sheet, Sears' net property and equipment only equals $7.028 billion.
These are three areas that I'm no expert in, and could possibly be the reason for the big rebound in SHLD. However, I think these bullish points are unlikely to be profound, and SHLD is likely a good short opportunity.
Trade recommendation: Sell