Today has been the best news for Hudson’s Bay (OTCPK:HBAYF) investors since the company's IPO in 2012. Sears Canada (SRSC) today applied for creditor protection under the Companies’ Creditor Arrangement Act. This does not mean that Sears stores will immediately close down, but for many of them, their days are numbered… While this news should’ve been anticipated for years now, the market had not factored it into Hudson’s Bay’s stock at all, instead of valuing it through a lens of maximum pessimism. Even after rallying 40% off its lows, and moving up 10% in Thursday's trading, HBC remains a screaming buy.
Immediate impacts of Sears’ actions
For now, day to day operations continue at Sears (NASDAQ:SHLD). Sears Canada has essentially filed for the Canadian version of Chapter 11. They are working on crafting a turnaround plan and required debtor approval to continue as a going concern. My heart goes out to the employees during this time, I can only imagine how terrifying it must me. In SRSC’s statement released this morning, they attempt to paint a rosy picture of the restructuring.
The Company's hard work to bring its vision to reality is reflected in reported growth in same-store sales in its two most recently completed quarters. Sears Canada believes this indicates that the new brand positioning is starting to resonate with consumers. The brand reinvention work Sears Canada has begun requires a long-term effort, but the continued liquidity pressures facing the Company as well as legacy components of its business are preventing it from making further progress and from restructuring its legacy assets and businesses outside of a CCAA proceeding. If granted, the Sears Canada Group will work to complete its restructuring in a timely fashion and hopes to exit CCAA protection as soon as possible in 2017, better positioned to capitalize on the opportunities that exist in the Canadian retail marketplace.
This is incredibly deceptive by SRSC’s management. As I laid out in my piece that advised investors to exit Sears Canada, management grew same-store sales a measly couple % by crushing margins and moving into off-price segments. Sear’s turnaround strategy has not worked and I see no reason why debtors would vote in favor of a restructuring so they can continue a failed strategy. I do not see Sears emerging from this...
Insight from Hudson’s Bay’s C-Suite
Regardless of if Sears Canada emerges as a going concern, they will need to rework their business model. Hudson’s Bay has experienced significant margin pressure competing with Sears Canada, which I laid out about a month ago in my piece on Hudson’s Bay. It should also be noted following the exit of Target Canada, Hudson’s Bay grew same-store sales at Canadian operations by high single digits two years in a row. I contacted Hudson’s Bay investor relations and got a few interesting piece of information for Elliot Grundmanis, VP of Investor Relations for HBC. Italicized is from Elliot.
I noted in my piece that the Hudson's Bay banner experienced robust same-store sales growth the two years after Target's exit from the Canadian market. With the ongoing collapse of Sears Canada, I'm wondering if HBC expects similar growth should they cease being a competitor.
We would expect to see additional sales gains should Sears exit the business. Lots of moving pieces still at this time though.
I know some HBC investors are concerned the company may be in the acquisitive mood for Sears Canada, he confirmed HBC are not potential bidders…
Of course, for as long as I can remember there have been musings of an HBC-Sears Canada tie up. Does HBC have any intention of bidding on SRSC assets?
As policy, we do not comment on any potential acquisitions, but Sears would not fit with our stated goal of being in the luxury, premium department store and off price segments of the market.
I was interested to hear whether HBC expects reduced margin pressure, but they would not break down HBC by banner, so I can only guess what compression has occurred. Any evidence I have is anecdotal, but Hudson’s Bay appeared to mark down their merchandise so they’d have direct competitors with Sears ‘The Cut’ line.
What Sort Of Impact will this have on HBC?
As I see it, Sears Canada customers are heading in one of two directions, Hudson’s Bay OR Wal-Mart (WMT). Sears sells clothing, furniture and appliances, with plenty of their locations in malls. Hudson’s Bay sells clothing, furniture and appliances, with plenty of their locations in those exact same malls. Wal-Mart operates in distinct segments such as food retailing and electronics. Most customers that shop at Sears already shop at Wal-Mart, but do not shop at HBC. I do not see large sales growth for Wal-Mart by this move, but it spells good news for HBC’s apparel and appliance businesses in Canada.
HBC's balance sheet flexibility also means they should be first in line to pick through remaining Sears Canada retail real estate. Considering the company has filed for bankruptcy protection, I don't know how much real estate is left on books, but HBC has a great track-record of sniping real estate assets off of distressed retailers such as Galleria in Germany in 2015. If anyone can find a diamond in the rough in Sears remaining assets, its HBC...
HBC’s Strategy is panning out
What’s so edifying about this today is twofold. I can never complain when my pair-trade (short SRSC, long HBC) pans out, but it's that HBC’s management has been vindicated. As they (HBC) laid out in their recent conference call, Canada and the US are overstored. This has largely been fixed in Canada as of today, and I hope HBC is preparing to grab Sear’s appliance market share. This shows their belt-tightening plan is the right one. Hudson's Bay's banners in the US will face future tailwinds from the eventual departure of Neiman Marcus (Pending:NMG), Sears (SHLD), Macy's (M) (at the very least the closure of many stores), JC Penney (NYSE:JCP), American Eagle (NYSE:AEO) and so forth. Just as Sears Canada is an omen for Sears US, Hudson's Bay is an omen for Lord and Taylor and Saks. This paints a much clearer picture to me for what really matters for HBC, its real estate monetization plans. Hudson's Bay wants to wait for improving store dynamics before they reduce their financial flexibility by taking real estate off their books. With a soon to be strengthening Canadian store base, I see the Canadian REIT IPO commencing in 2018.
This is amazing news for Hudson's Bay investors. Same store sales growth Hudson's Bay, Home Outfitters and Hudson's Bay Home will experience in the coming year will grow earnings, the share price and bring with it renewed investor confidence in HBC's ability to monetize its real estate assets. Despite the stock's recent rally, the company still trades at 1/3rd the value of its real estate portfolio, according to multiple independent firms. HBC now offers two potential tailwinds for investors, improving retail and great real estate.
Disclosure: I am/we are long HBAYF, WMT.
Additional disclosure: Short: SRSC, SHLD, JCP,
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