Numbers Check on Sears Holdings - It's Cheap 54 comments
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With its market price declining daily, giving me the opportunity to pick up even more shares, I thought I’d present a very rough look at how the market is valuing Sears Holdings (SHLD) right now, putting reasonable numbers to a rather abstract investment idea.
Reality check number 1: In normal times, Sears is generating a good $50 billion in sales. $50B. The current market value hovers around $10B, or one fifth of sales. Add in net debt ($2.7B in LT debt and capital lease obligations plus a $1.1B pension shortfall) and subtract cash ($1.4B), enterprise value goes up to about $12.5B. Is Sears worth a quarter of its annual sales? Well, that depends on profit margins, which had been improving until late last year and into this one. Right now, margins stink. EBITDA margin came screeching down to 4.4% last quarter, which is awful. Eddie has said in the past that Sears should, or aspires to, obtain a 10% margin, comparable to Wal-Mart and JCPenney.
Can Eddie get better margins out of Sears? I’m not sure, but what’s it worth if he does?
Retailer
Assuming $50B in sales, and an 8% EBITDA margin, short of his goal, Sears is producing $4B in annual EBITDA. Take out normal depreciation, a billion, and EBIT is $3B. Take out another billion in taxes at 35% rate, and $150mm in interest payments, we’ve now got $1.85B left in net income. Add back depreciation, we’re at $2.85B, and subtract Eddie’s usual level of capital expenditures, about $550mm, and we arrive at $2.3B in annual free cash flow that Sears is capable of producing with 8% EBITDA margins. If he gets to 10% margins, watch out kids. There’s another $650mm in fully taxed free cash flow.
What’s an ‘ok’ retailer with $2.3B in free cash flow worth? I’d venture about 10-12 times that number, or $23B - $27.6B. Looks nice on top of the current enterprise value of $12.5B, no? At these prices, Eddie is probably buying back shares in gobs. With 131.7mm shares out at the end of Q1, that number is probably down to 128mm or so. At 10X FCF, backing out the net debt, Sears is now worth $160/share. At 12x FCF, Sears is worth $195/share. The $650mm in FCF from 10% margins would create an extra $50-$60/share in value. So, as an ongoing retailer in a better environment and some margin improvement, Sears could be worth anywhere from $160 to $255/share.
So that’s what Sears could look like, in a steady state, if it improves the retail operations to 8% EBITDA margins, or even his goal of 10%. This can be done, but we’re not sure it it will be done. What’s might Sears be worth summing up its current parts at a reasonable valuation?
Sum of the Parts
Well, Sears has a got a couple of things. First, the real estate bank. Second, you’ve got readily salable brands in Lands End, Craftsman, Kenmore, and Diehard. Third, the Sears Canada operation. There’s more in there, like the Home Services business, but we’ll place no value on those for now, out of conservativism.
Taking our enterprise value, $12.5B, subtract out Canada. What’s that worth? Last year Canada produced about $600mm in EBITDA. Looking at a buyout scenario, a reasonable and conservative multiple for Canada is 6x, or $3.6B. Sears Holdings only owns 70% of that, so they only get $2.5B in the sale.
The brands are a wildcard here. Very tough to model the value of these brands. All we really know is that they have tremendous brand recognition, and they generate tens of billions in annual sales. That’s about it. The only number we have to start with is the $3.3B on Sears’ balance sheet for brands and intangibles. Let’s call it $3.0B. These brands probably have way more value than than that, but as a conservative guess, I’ll put it there. I could be wrong here, so discount my value at your leisure.
Here’s what we’re left with:
$12.5B - EV
-$2.5B - Canada
-$3.0B - Sell our brands
$7.0B - Real Estate Value.
According to Bill Ackman, Sears has 250mm in real estate square footage. Based on my own analysis of how Sears reported their sq. ft in the 10-K, he’s including some 100 year leases which are akin to ownership, which is fair. In strictly owned sq. footage, the number is substantially less than 250mm. Being familiar with the intensity of Ackman’s approach, I’ll take his word for it, however. If I had a good way to verify this, I would. I don’t, so let’s hope Bill is right.
With $7.0B in value, on 250mm in square footage, the market is placing a value of $28 per square foot on the Sears real estate collection. In the Barron’s article last year, they presented this table (click to enlarge):
Target at over $300 sq. ft. Home Depot near $275, JCP near $150/sq ft.
Using this as a baseline, we can reasonably say $100/sq ft. for Sears. May be a tad high, may be a tad low, I can’t say for sure. I think it’s an conservative assumption, however, and that’s my point here.
At $100/ sq ft, the value of Sears’ real estate is $25.0B. With the market valuing it at $7.0B as we pointed out above, there is $18.0B in real estate value not being recognized by the market at this point. That’s $140/share on 128mm shares outstanding:
Current Price: $75
Net Debt: ($19)
Unrecognized Real Estate Value: $140
Value: $196
Thus, I can reasonably estimate that Sears’ intrinsic value, be it as a strict retailer or just a collection of assets, is worth twice its current enterprise value, with much upside. On the upside, it’s obvious that successful retailing can make Sears worth three or four times what it’s being valued at today. On the downside, we see that Sears has assets worth not only today’s enterprise value, but much more.
What am I leaving out? We have a very, very talented capital allocator running the place, Eddie Lampert, with a whole pile of capital to allocate. We’ve got a new structure that’s yet to take hold, promising autonomous control over individual units. There’s a chance that the market might value Sears at better than 10-12x FCF, if retailing works out. There’s a (good) chance the real estate is worth more than $100/sq ft. There’s a good chance the brands are worth more than $3.0B. We ignored some other assets and operations Sears owns. Et cetera.
It’s tough to attack the valuation of a pretty abstract entity like Sears. I still don’t know how in god’s name I would classify this company, the right way to value it, or what lies in the future. The only approach that makes sense is a conservative one that’s probably not correct, but gives us a baseline to work with. The main goal is not to overstate the value of these assets or cash flow streams. That’s why I’m not running around slapping 25x earnings multiples or some random book value multiple to make it look nice. If you go the conservative route and still see tremendous value, the upside options are probably not valued into the price. There’s the key to a potentially successful investment operation.
On top of this, you’ve got the incentive and motivation of Eddie’s career on the line to make something work, with 60% of ESL in Sears. That may be worth more then every asset on the balance sheet.
I could bring you through a more detailed analysis of every part and parcel of the company, every little number and footnote. Believe me, there’s plenty to analyze with a $50B company, I’ve been trying. I always get to the same conclusion: Sears is cheap.
Disclosure: I own shares of Sears (SHLD)
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to Cramer. Why criticize someone you don't follow? There are
probably many bargains out there. I feel more comfortable receiving
recommendations from Jim Cramer. gardengirl
And whats this nonsense with a 10-12 times cash flow multiple? We are in the middle of a recession with plenty businesses selling at half that multiple.
The Kmart brand is a millstone around the neck of the company, tied to an anchor, hurled off the ship in a gross of cement shoes. Saying that the brand is hopelessly void of value gives it way too much credit. The Sears brand is not that far behind.
What they have are a few decent merchants and a couple of great brands, as you mentioned. Eddie's not an operator but pushes knowledgable senior management around as if he is. I left before Lewis got pushed out but you could see the writing on the wall. Johnson knows the business probably better than anyone but I would be very surprised if he gets the leeway to make the calls he wants with Eddie and Crowley hanging over his desk like a summer fog on the Golden Gate.
I'd sniff at SHLD for a trade from time to time but that's about it.
Cars in the parking lot are the future.
Sears and KMart are dead.
---------------
Now I hear Sears in interested in buying Steve & Barry's?
They don't enough losers to their portfolio?
S&B's was a pyramid scheme and now that it has collapsed Sears wants in...LOL
Let me ask you this who does the trading for his wife and childeren.
He fails to mention that on his show,he says he can only trade for charity,which is true,but who does their trading.
I called the show many times and never got a response.
"LOSE MONEY" WITH JIM CRAMER
My local Sears and KMart (DC subs) are always full. One (Kmart,Springfield, VA) is adjacent to a Trader Joes with high traffic flowing through the complex. Another (Kmart, Annandale) is a stand alone and overflows because it is the only retailer in the area. The local Sears is in a shoddy mall, but the store is very active. I was in the applianced section last weekend and it was very busy. I am sure that there are many solid locations and others that may eventually be closed. It's difficult to determine what will happen.
I certainly cannot value the company or predict the immediate future of retail, but Sears seems like a decent situation for a long term holder. Munger says you always need to compare the investment wil your opportunity value. Are there better investments???
For what it is worth, you are in good company with Fairholme, Pabrai, Soros, Price, etc. Keep up the posts.
How do you arrive at this number? Dreaming?
End fiscal year 08 cash from operations was $1.55 bil and cap ex about 570 mil or roughly $1 bil in fcf. You gotta believe this number will be dropping off big as the avg consumer is broke.
Who is going to buy these retail properties?
Why did eddie squander billions in buybacks at avg $132 share price with a unfunded pension of over a billion? F%^$# idiot should have funded this liability first and paid down a little more debt while overpaying for his stock.
The ONLY hope I see here is a re spinoff of the properties into a reit then over time diversifying the tenant base as sears closes stores and brings in real retailers with growth potential that can pay rent.
no good investments on the surplus of cash, no ROE.
buying back Sears stock at higher prices.
no management
Warren Buffett does not own a share of Sears.
holding on to the real estate that is depreciating without any dividend.
no plan
Please be realistic how about that purchase of Citi group at its highs by Lampert.
My grandmother knew not to touch the financial because of the subprime.