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Don't Forget Sears' Housing Connection

Very interesting viewpoint on closing stores before Christmas. I guess we shall see early next year how many more stores get cut.

What is your opinion on how low domestic cash can safely go considering the revolver will get reduced in March 2010, and, being majority owned but not wholly owned, what could Eddie do to repatriate cash from Canada??

Don't Forget Sears' Housing Connection

Why close stores just before Christmas? I'd assume they are total dogs, or their leases are expiring now. That would be a good question to ask Eddie or Bruce at the annual meeting next year. Perhaps Eddie's reading this and will answer it in his letter to shareholders next year.

If you expect deflation, then i understand your forecast of down 25% sales three years for now. I don't. I think inflation will pick up, and moderate inflation is the friend of the retailer.

The margin trend i'm referring to is Kmart between Q3 2008 and Q1 2009, margins up steadily each quarter. Q4 op. income for Kmart was $274 mil, up from $237 mil the year before, even on 5% lower sales. You don't need sales increases to generate higher margins and profits, you really just need sales to be somewhat stable. I don't expect sales to rise, I do however expect them to flatten out, which would allow gross margins to improve.

Also, first quarter this year, total company margins were the 2nd highest since the merger, so It's possible for Sears to make tons of cash, but it's frustrating to not have any idea what to expect.

Don't Forget Sears' Housing Connection

Do you honestly think sales will be down 25% from here in three years? Are you considering higher than average inflation? Do you not think there's pent up demand for appliances out there? The Whirlpool execs say on every conference call that people are delaying purchases of appliances, even replacements for appliances that are beyond repair. How many people out there do you think are washing dishes by hand, or doing laundry at the laundromat while they are out of work? What impact do you see from a govt. program to replace old appliances? Sears has 1/3 of the appliance market.

Yes Sears has declining sales, but did you not notice the improvements in gross margins over the past year, with the exception of this quarter? Was that a fluke? The major hit to margins this past quarter was at Kmart, due to liquidation of inventory at stores that are closing. Remember in the most recent press release, Sears only expects $5 million in store closings expenses for the rest of the year. Sounds to me like they are winding down this round of store closings, so we should get a clear view if the margin trends that were in place come back. A small improvement in gross margin rate on even $35 billion is still huge. All things equal, a 1% improvement in gross margin on $35 billion equals $3.00 of earnings. The other side of being so leveraged to gross margin, in my opinion, was the problem in the past. Eddie never had intentions of growing the store base, yet he did increase inventory levels in 2007, which turned out to be a bad decision. In my opinion, that glut of inventory was the cause of the sharp decline in margins and massive drop in earnings during 2008. Assuming inventory is under control, Sears should still generate FCF sufficient to repurchase the remaining float over the next couple years, and I still do see a Berkshire Hathaway type vehicle in the works. What else would Eddie do with the cash? Declare a big dividend and go home? That's not his style. I think once the float is gone, Eddie will be more open to making open market purchases of stocks, more total return swap investing. Couldn't he do that today? Sure, but as soon as he does, the stock would no longer sell below book value. In an old letter to shareholders, Eddie said that his goal, just like Warren Buffets goal, is to increase the per share value of the company. Whats more beneficial to the per share intrinsic value of Sears, buying stock well below book value, or investing elsewhere? There's always a bargain out there. In the mid 90's bull market he found IBM right before it rallied 500% in five years. His Autozone position has run from $20 to $150 during this ten year bear market. Eddie can find winners to invest Sears cash in. I'd much prefer there be fewer shares outstanding before he begins to do so.

And yes, if Eddie could do it over again, he probably would have sold much more real estate in 2006-2007. He even hinted at that at the annual meeting in May, saying, that Sears was never a real estate play, but whether or not that was the right decision remains to be seen.

Eddie's a smart dude. Sears will generate a lot more cash than most think. The inventory values alone provide a massive margin of safety. It's fun to watch this unfold and I'm happy to be a shareholder, even if they are a crappy retailer.

Don't Forget Sears' Housing Connection

I am not trying to write a ringing endorsement of Kmart. I agree with you. The store in my town will probably close. It's probably not popular with the landlord. Less and less people will shop there in the future, and the stores next door to Kmart probably wish they weren't next door to Kmart. All of this is probably true.

The disconnect is when people apply that thinking to the stock and assume it must be a terrible investment. It's not. Kmart generates hundreds of millions of free cash flow. It was used as a platform to acquire Sears which generates hundreds of millions of free cash flow as well. The whole company is priced like it's going to die. Hey, tobacco use has been declining for 40 years in this country, and cigarette companies keep churning out cash. Kmart and Sears will do the same, and when it's all said and done, Eddie and whomever is remaining owning the shares will be sitting on a huge pile of cash too.

Don't Forget Sears' Housing Connection

Here's how Sears can buy up the remaining float in the next two years.

Sears has generated about 250 million of free cash flow during the first half of this year. It was ugly how they did it, as most came not out of GAAP earnings but rather out of the difference between the depreciation charge and actual Cap Ex. Ugly may be ugly, but cash is still cash. The 4th quarter is when SHLD will make most of it's money. Last year they earned $2.94 per share during the 4th quarter, so assume it's less this year, assume it's $2.50 per share. Then add back $100 million of of depreciation not spent and you get around 413 million of cash flow. Subtract pension and you're around $650-700 million free cash flow for the year. Assume next year is roughly the same, but you have to subtract more of a pension cash drain next year, so next years free cash flow is more like $450million. Now as you said earlier, Sears must decrease inventory as sales decrease. Assume sales fall 7% next year. 7% of $6 billion of net inventory and you have $420 million of cash that should be taken out of inventory. No long term debt is due until 2011, and obviously Eddie Lampert will not pay a dividend. One would have to assume that all free cash flow and most of that inventory that was converted to cash will be used to repurchase stock. $700 million+ $450 million +420 million equals $1.57 billion cash. At today's prices thats 24 million shares, and remember, there's only about 26 million of float. This of course assumes the stock price stays the same, which it probably won't, but it also assumes Sears fails to earn more free cash flow than we are projecting, even though they probably can. It also assumes that none of the four mentioned majority holders decide to sell, and if they do, I withdraw my entire case.

Don't Forget Sears' Housing Connection

A lot of companies have stopped their 401K match. You have to cut expenses when times are hard. I don't see any correlation between cutting 401K matches and Eddie not wanting anyone to share the wealth.

Also, your statement that Eddie will do well but others may not, while somewhat true, implies that most people purchased the stock high and are underwater. I for one did not. Not that it's relevant to business analysis, but I think the general attitude of most out there is that anyone who's long bought at $190 and is suffering, hanging on to a dream.

When i say "float" i refer to shares outstanding minus Eddie's, and I also net out Thomas Tisch, Bruce Berkowitz, and Bill Miller. Could they sell? Sure, but Tisch is on the board of directors and has owned 3+% of the company for years, Berkowitz owns over 10% and seems very content to hold, Bill Miller is a friend of Eddie Lamperts and seems to believe very much in him and his strategy. I also net out the millions of shares held by index funds, SPY spiders, QQQQ's, RTH, Vanguard S&P500 index funds, they own probably 5 million shares between them. There's really only about 26 million shares out there actually trading. If Sears continues to generate a mediocre $600-700 million free cash flow as it now is, after funding it's pension, it could wipe out 38% of this remaining float in the next six quarters. The rest of the float is sold short. I don't see how it could be a good idea to bet against it here.

What do you think Eddie will do with hundreds of millions of free cash flow when there is no float left? What would the market response be if he bought 25 million Philip Morris and 25 million Pfizer one quarter? The stock would skyrocket. I'm not saying it will happen, but he's not going to pay a dividend. The worst case scenario is he begins selling his ESL shares directly to Sears and cashes out while maintaining the same ownership %. Could I be wrong about all of it? Sure, but again, there's a massive pile of inventory backing up today's purchase price, so even if I am wrong, I don't see much downside.

Don't Forget Sears' Housing Connection

Kmart will earn enough during the 4th quarter to justify it's existence. Prior to this past quarter, gross margins had been trending higher for nearly a year, and if you believe the 10Q, the only reason gross margins stumbled is because of inventory markdowns at the stores that were being closed. We will have to wait until this round of store closings are finished to find out if that is exactly the truth, but it's not hard to believe. Sears/Kmart turns it's inventory only about 4 times per year. I can see them having to sell at fire sale prices or even dump inventory onto a closeout company just to get rid of the slow moving stuff.

I'm not trying to argue that Kmart is a nice store. I live very close to one. The store is old, the floor tiles are cracked, the sign out front is dirty, things ring up at the wrong prices sometimes, the shopping carts are old and rusty... but there are always people there shopping. always. I don't think they spend much at all on CapEx, nor should they. Whats the point? The typical Kmart customer could care less if the floor tiles are cracked or the lighting isn't great. Wait for Q4 to be released. Kmart will have hundred of millions of operating income on lower sales. Thats all they need. I think Eddie's strategy is the right one. What would you do? Spend all the cash flow on remodeling the store knowing that Wal-Mart will still kill you in the end, or milk it for cash and run off the leases, pay off debt, and wind it all down? Eddie's doing the right thing, in my opinion.

Don't Forget Sears' Housing Connection

dingo joe,

you say, regarding Kmart, that you're not sure "whats left will be even viable when the underperformers are weeded out"... Considering that Kmart is profitable, at least annually, then whats left after closing underperforming should be a more profitable company. Not sure how you could assume anything different.

Buybacks are an easy target now that nearly all stocks are down significantly from their highs years ago. I can give you a long list of companies that bought back stock too high, and many of them financed it with tons of debt. Sears, atleast didn't finance any buybacks with debt. I would make the case that the prices Eddie Lampert paid were not high considering the situation at that time. Sears has $50 per share of Net Inventory, I think you'd have a hard time finding anyone in 2006 and 2007 that thought Sears real estate values were worth less than $70 per share. Lands End was purchased for $1.9 billion in 2002 and has just finished three consecutive years of record profitability. To think it's worth less than it's purchase price doesn't make sense, which means Lands End alone is worth $16 per share. Add it all up and consider that in 2007, Sears was generating about $13 per share of free cash flow and I don't see how you could say that Eddie Lampert was paying too much for the shares when he was purchasing them for $145 per share. Rather it would seem that he was paying something close to liquidation value at that time. Today while nearly all others have suspended their buybacks, Eddie Lampert is still buying in millions of shares. No one talks about the fact that he's purchased 5% of the company at half of book value in the past year. Also remember that when Sears stock was at $190 per share, Eddie wasn't repurchasing stock. He instead was hoarding cash, and investing in total return swaps. People seem to have forgotten that he actually earned tens of millions of dollars for Sears through total return swap investing. Anyone that argues against that can go back and add up the gains and subtract the losses between 2006 and 2007.

Another thing i think people fail to realize is that Eddie Lampert's investment in Sears began with a $750 million investment in distressed Kmart debt while it was bankrupt. He was buying debt at 20-40 cents on the dollar. Kmart was taken out of bankruptcy and Eddie's Stake is today worth $4.3 billion dollars. Roughly a 500% return since 2002. Is that what you would consider a failure? I've met very intelligent people that seem to think his Kmart/Sears investment was a terrible mistake. I can't see how it's possible to think that..

Sears may be a failing retailer, but I'd make the arguement that Sears being a retail turnaround isn't the strategy. It's more likely that it's a retailer in runoff. At the rate Eddie is repurchasing stock, there won't be any float left to buy in about two years. At that point, Eddie can do anything he wants with whatever cash flow and assets are left. Thats the lure of owning the stock. Fortunately, for anyone who can look at Sears objectively from this viewpoint, the price today is a once in a lifetime opportunity to partner with Eddie at an incredible price. If it doesn't work out, the $50 per share of net inventory alone makes for a great backstop.

Sears' Q1 Surprise Profits May Be Fleeting

No one will mention that Sears Holdings gross margin was the 2nd highest in the history of the merged company. NO ONE will mention that. That's why the earnings blew away expectations. The business may be in decline, but it's being run well given the situation. Also, if they just reported the 2nd highest gross margin in the history of the company, then ask yourself, What happens when housing recovers?

All my life i was told that investing in cigarette companies was a bad idea because they didn't have a sustainable business model, as their customer base is literally dying every day. Smoking has been declining for 40 years straight, yet Philip Morris, i believe, has been the best performing large cap stock at nearly any point of those 40 years. Why? Because the stock has been priced at distressed levels for so long, yet the company keeps churning out cash through cost cuts, consolidation, running the business better, and it keeps sending that cash to shareholders via share buybacks at distressed prices. As long as Sears remains at distressed prices (below net inventory value qualifies), then all they need to do is run the company for cash and buy back stock. That's it. Game over. In a few years, there won't be any float left. Unless you can argue the retail operations won't survive a few more years, the stock is a bargain.

Expect Continued Selling Pressure on the Markets

hey rigster,

yes i was there. i asked the question regarding inflation. did you get a chance to ask anything?

Eddie Lampert Heads into Memorial Day a Happy Man

2houndz,

Why would Sears have to lease these spaces all to Macy's or anyone for that matter? Why not sell them? Before you respond with, "Who would want to buy them?" How about the mall owner itself? Target? A movie theater? You cannot say that 150,000 sq/feet of mall space is worth zero. You can however say, "Mall owners couldn't get the cash to buy them even if they wanted to" which is true, today. But who says Sears has to sell today or next year? Why sell at all in this economy? Sears is making good money already, and can wait ten years if need be. Do you not think in ten years these properties will be worth at least their current tax values? We're entering a multi-year period where expansionary CapEx is being cut to the bone. This sets up Sears for a great opportunity to sell off it's real estate many many years from now, should it wish to. Wouldn't you say that's a fair statement? Your post seems to suggest Sears real estate is worth very little. I can't possibly see how it's worth less than $10 Billion in any normal economic environment.

Expect Continued Selling Pressure on the Markets

Andrew,

Two things, first, can you explain what you mean when you say that it's a "real possibility that mark to market accounting changes helped significantly" with regards to Sears earnings? What accounting changes are you referring to?

Second, still on the subject of Sears....What are "non-existent inventory additions"?

Sears Surprises Everyone

Is it really a surprise? I've been saying on here for over six months that gross margins were improving, beginning with Kmart, and then with Sears. It doesn't take much of a brain to figure out that a small increase in gross margin on a revenue base the size of Sears, divided by a paltry amount of shares outstanding, equals per share earnings and free cash flow exploding higher. I would think this company can easily hit $8.00-$9.00 per share of free cash flow this year. Too bad for all the shorts who's only research was to listen to the garbage being posted in the press about how bad the company is, how no one shops there, and how they were going bankrupt this year.

Ackman, Lampert and the Sears Canada Test of Patience

Todd,

Looks like your serious girlfriend and your torrid love affair have accidentally crossed paths.

Lampert's Patience Is Rewarded as Sears Holdings Buys More Sears Canada Shares

sclarksons,

i agree with what you say about Sears being more of a holding company focused on shareholder value.

Did you read through the 10-K and notice all the transactions made during the year? Buying debt and booking gains, sold Sears store in Calgary for a huge gain, sold Toronto headquarters for a huge gain, bought 9 previously leased stores and distribution centers..... It's funny how once upon a time everyone talked about how Eddie would run SHLD as an investment vehicle, and now that it is becoming obvious that he's really doing that, people just trash him for the stores.

Also, regarding your $500,000 per store... i think that's way to low. I have gone to many county tax websites and found tax values for the stores, the lowest i've ever seen is the Sears in Eastland Mall in Charlotte.... which is being closed next month. It's tax value is $5 million. Most of the stores have a tax value around $9-14 million, and the highest i've ever seen is in Anchorage Alaska, at $25 million.