Sears May Not Be Berkshire, but It's Worth Buying on Weakness

The shares of Sears Holding (SHLD) were weak on Monday (-5%) on a huge downward revision for earnings in Q4 for FY07. The company is now looking for earnings of $5.13 to $5.96 vs. analysts' consensus of $6.64.

I have seen a lot of commentary about this development and I think a lot of it misses the point. Some thoughts:

1) The retail environment is challenging right now. With all the concern about the housing market, high gas prices, the over-leveraged consumer and the threat of recession, it is no surprise that the consumer may be scaling back a bit.

2) Sears is a retailer. With both the Sears and K-mart brands, SHLD is subject to the ebbs and flows of the retail marketplace. It would be surprising if SHLD could do much better than the average retailer in this environment. That said, the announcement was a surprise to me and obviously others who follow the stock.

3) Sears may or may not need a make over. A compelling article in the WSJ contends that Sears needs to make massive changes to compete in the "brave new world" of discount retailing. When has discount retailing ever been an easy business to be in?? I think that IF Sears needs big changes, I would rather have someone like Mr. Lampert at the helm than someone who has only been in retailing his or her entire career.

4) Valuation is very cheap now, but the upside is hard to measure. Some people were looking at SHLD as an asset play with all of its real estate. That way of valuing the company may not make much sense right now, but the real estate is not going away. I suspect that the current EPS estimates will represent something close to trough earnings and so we may not expect a premium multiple on them. If the company could earn $9.00 per share again (the result for FY06), what would the stock be worth? The company was buying back stock at $131 based on expected earnings of $7-8 or so. I think the shares could eventually move into that range again, but it's hard to say for sure at this point.

5) Stay with Lampert. Okay maybe he's not Warren Buffett (and SHLD is not Berkshire Hathaway), but he knows how to squeeze out exceptional value out of his investments. As soon as the news on Sears hit the tape, the talking heads were ready to write Mr. Lampert's business obituary. I think this is highly premature. I suspect that he still has a few tricks up his sleeve to shore up his at-risk capital and help out all shareholders. I am happy to continue to hold the shares.

I started buying the shares back in November and here is what I wrote when I bought some more in December:

"I don't know if this year-end volatility is due to tax-loss selling or not, but I am happy to use it to add to my position in SHLD. Nothing has changed since I bought the stock on November 30. Here is what I wrote at that time:

After months of looking at Sears, I finally used the recent weakness to take the plunge. The third quarter was a disappointment but many investors may be forgetting that SHLD is not just a retailer - it is part of Eddie Lampert's considerable investing legacy.

So far he has been able to cobble together a couple of bankrupt, lower-end retailers into an asset that generates about over $1 billion of cash per year. The company repurchased 6.7 million shares in Q3 (at prices around $131) and used some of its considerable cash on the balance sheet to stock up the stores for the holiday shopping season.

This year may not be the best for shoppers or retailers, but I think Mr. Lampert can take a longer view here and will use any weakness in the stock to buy up more of the shares. I can see the shares moving back to the $140 level in the next 6-9 months, assuming the earnings estimates hold ($7.71 for fiscal 08 and $8.27 for fiscal 09) and the US economy avoids recession.

Many people seem to think that Sears may be unable to sell assets in this credit crunch environment, but I think that good strategic deals still make sense and any reasonable banker (oxymoron?) would be happy to lend money to a buyer of Sears' assets that would be a natural fit to an existing business.

Recall that as late as October of this year, a Barron's article suggested that a Sears breakup could fetch as much as $300 a share. Finally, Mr. Lampert is one of the most successful investors out there and I am willing to invest shoulder to shoulder with him on this one.

Comments

[borisa:]

wait a minute, that doesnt make sense. "valuation is cheap, but upside is hard to measure." tell me, how exactly do you know what a cheap valuation is if you can't measure the company's upside?

2008 Jan 16 09:33 AM

[Richard Shi...:]

You wrote:
"If the company could earn $9.00 per share again (the result for FY06), what would the stock be worth? The company was buying back stock at $131 based on expected earnings of $7-8 or so. I think the shares could eventually move into that range again, but it's hard to say for sure at this point."

This, to me, is why Sears Holding is not a buy. 2006 was for all intents and purposes the pinacle of a housing and real estate bubble that Lampert sold in to. Unfortunately, he also bought in to it as well at $131.00 per share when the stock is now trading at about 35% less, not a brillant use of capital in hindsight.

Also, what "tricks" could Lampert have up his sleeve, I read in the 10-Q about the total return swaps he invested in, but if I read it right he LOST money on those. What "tricks"? See that is the thing, everyone who promotes this stock expects this guy to pull a freaking rabbit out of his hat while at the same time comparing him to Warren Buffett. Buffett did not pull any rabbits out of his hat, he bought under-valued businesses and held them for years and years and years and he had a great advantage over Lampert, NOBODY including him knew he was "Warren Buffet" when he was 42 years-old so nobody valued his holdings with expectations of magic tricks.

2008 Jan 16 07:54 PM

[Joser:]

Rick, hot-damn! The last sentence makes so much sense.

2008 Jan 16 10:38 PM

[robert99:]

Hey Mike, remember me? Remember my prediction that LEN would return to 2002-2003 valuations? Looks like I was wrong on that - I was exactly one year too optimistic. And guess what? I'm still not bullish on housing stocks. I think you're going to be down about 75% on your basket before you see a bottom, and there's a pretty good chance a few will go out of business. I also think that, along with all of the other posters, that you are entirely wrong about SHLD. Sure, it might rally a bit after the FED cuts rates, but lower interest rates do not immediately solve problems. The market will turn lower, and SHLD will probably see $70 before the year's over. I hope you still have a lot of cash reserves so you can DCA your way down, because housing does not turn on a dime, and generally speaking, as housing goes also goes the economy.

2008 Jan 26 05:25 PM

[nyka:]

When's the last tlime anyone bought apparel from Sears? Buyers of tools and appliances also are avoiding this staggering enterprise,
choosing instead to try Home Depot or Lowe's, both of which are experiencing their own financial problems. Within the next three years, Sears will have gone the way of Montgomery Wards. And only Lampert and his investors will shed any tears.

2008 Jan 30 08:06 PM

[BULRUN100:]

Bunch of neagitive people with nothing to back up thier negativity ALL retail is down good ones and bad ones .We know where SEARS stands(BAD side).If your investing for SEARS(retail) your in the wrong investment.

2008 Feb 16 08:25 AM