Seeking Alpha
Long/short equity, growth at reasonable price, research analyst, deep value
Profile| Send Message|
( followers)  

This is the second part of a series on Sears Holdings (NASDAQ:SHLD) with the focus of this part on the case study presented by Fairholme a few weeks back.

The company operates as a specialty retailer in the U.S. and Canada. It operates under the Kmart and Sears segments with major brands such as Kenmore, Craftsman, DieHard, Joe Boxer, Lands End, and Jaclyn Smith.

Bruce Berkowitz is well known as a deep value investor and runs the Fairholme Fund (MUTF:FAIRX) that is a major shareholder of Sears and prepared the case study. Also, Bruce was named the U.S. Stock Manager of the decade by Morningstar back in 2010 which should give investors more confidence in the story.

As mentioned, this is the second part of a series. Last week, the first part focused on the highlights of Q2 earnings. Finally, a review later this week of the pending spin offs will complete the series.

Intrinsic Value

A major theme in the investing of Bruce Berkowitz is that the market price doesn't equal the intrinsic value of a company.

In the case of Sears, Bruce believes the market cap of around $6B doesn't equal the value of the following items:

  • Real Estate
  • Core Brands
  • Integrated Retail Operations
  • Home Services
  • Logistics
  • Other Business Units
  • Net Inventory
  • Deferred Tax Assets

Real Estate

The value of the real estate is probably the most debated part of the Sears value equation. Most investors take a look at a dilapidated Kmart store and make across the board negative assumptions on total value.

According to Fairholme, the company has significant value in low cost owned properties and long-term below-market leased sites.

Table - Sears Real Estate

StoreKMARTSEARS DomesticSEARS CANADA
Full-line Properties1,305867122
% Owned16%60%11%
% Leased84%40%89%
Avg Sq Ft Per Unit95K133K128K
Total Sq Ft125M116M16M

Worth noting is that a majority of the owned properties are the Sears Domestic line stores that typically are mall-based with favorable locations. Also, the value of the real estate will be based on the income it can generate by another retailer and not the income currently generated by Sears' retail operations.

Another key point is that comparable REITs such as Simon Property Group (NYSE:SMG) and General Growth Partners (NYSE:GGP) trade at considerably higher multiples to square footage. Naturally these companies have more diverse client bases, but ultimately similar properties should have the same value.

In the case of Simon, its stock is worth 8x the value of Sears Holdings yet it has less square footage and none of the other assets of Sears.

The company also owns a massive 2M sq/ft headquarters, outlet stores, hardware stores, distribution centers, auto centers, and service facilities that have considerable values.

Brands

Most investors generally accept that the various brands such as Craftsman, Kenmore, and DieHard have considerable values on a stand-alone basis. In fact, these top brands were valued at $5.6B in early 2005.

Regardless of the perception of Sears, it remains the leading retailer in home appliances, tools, and major exercise equipment.

Last year, research suggested that these main brands could be worth over $19B if as independent brands each one was able to obtain market values of comparable publicly traded brands. By externalizing brands that have too long been held back by declining Sears' retail stores, the brands could have much broader reaches and hence values.

The updated comparative brands are now worth over $21B with considerable gains made by Stanley Black & Decker.

Brand potential / market value:

  • Stanley Black & Decker (NYSE:SWK): $11.3B
  • Whirlpool (NYSE:WHR): $5.8B
  • Energizer (NYSE:ENR): $4.4B
  • Total: $21.5B

Since the writing of that article, Sears has made a few more steps towards developing these brands such as launching DieHard alkaline batteries back in March. While a big step in the right direction, it is still amazing that each of the above companies has similar or greater valuations to the whole Sears operation.

Though Fairholme never presented any attempt at a similar type of comparison, the value potential is significant in the brands alone, especially when unleashed from dying retail stores.

Liquidity

According to the case study, Sears has the following liquidity that adds up to $8.7B.

  • Cash and Equivalents of $800M
  • Domestic Credit Revolver of $1.8B
  • Canadian Credit Facility of $600M
  • Net Inventory of $5.5B

Remember that liquidity fears were the major reason for the plunge to below $30 back in January. All of the above options suggest that liquidity is not an issue. Not to mention, Sears has the ability to close or sell stores to generate cash from liquidating inventory or obtaining the proceeds from a sell.

Catalysts

On Page 16 of the case study, Fairholme presents several potential catalysts such as housing starts, home sales, and residential investment. Being that Sears remains a major retailer of home appliances, tools, and lawn equipment, a large rebound in home starts and housing sales could become a major catalyst for Sears.

Conclusion

Considering the large investment in Sears Holdings, this following quote has to sum up the opinion of Bruce Berkowitz on the stock:

"Investing is all about what you give versus what you get."

The case study doesn't provide any indication of what the fund leader sees as the true intrinsic value of the stock. The stock traded as high as $90 back in early 2011 so one can only assume he sees the ultimate value as significantly higher than that price.

The real estate, major brands, and plenty of other assets provide investors the opportunity to get more than what they give for the stock.

Source: Get More From Sears Holdings: Part II - Fairholme Case Study

Additional disclosure: Please consult your financial advisor before making investment decisions.