Tuesday, October 2, 2012

Why I Own SHLD

I first bought Sears Holdings (SHLD) in fall of 2007 at around $135 (it is $57 today). Back then the financial crisis was just beginning to reveal itself. That summer, we heard the first tremors of the earthquake from the large banks, but by the fall of that year the S&P 500 was actually at new highs. I, like many others, did not heed the warning and pull out. Instead I was looking for new ideas for investment growth. I knew the market was priced quite rich. So, I had to look in harder for companies with good earnings, cash flow or book value. Without realizing it, I was looking at more risky companies which had good numbers on paper. That was one thing I learned from the financial crisis: don't force yourself to have some investment target, if the market doesn't offer you any bargains just sit out.

Anyway, back to SHLD, I opened my position in 2007 mainly because of a very bullish Barron's article, which you can find here. The article actually doesn't add much more than what is known about the company. SHLD is a retailer run by Eddie Lampert. Its main holdings are Kmart and Sears, two underperforming retail chains with storied histories. Lampert is someone who avoids the limelight. He does not give guidance. He does not give interviews. But he does give shareholders his thoughts in his quarterly letters to shareholders.

Ever since he took over Kmart during bankruptcy in 2002, Lampert has been slashing investments in the stores while using its cash flow to buy back shares. This strategy has allowed him to increase his stake in the company. Now he owns 64% from less than 50% before (Kmart took over Sears in 2004). The financial performance is another story. The annual revenue has declined from $50Bil to closer to $40Bil now. SHLD is trading at around 1.2x book value. The market cap of $6Bil is less than the inventory on the books. SHLD has been moderately profitable in past years but that may end this year. The market wonders how this can continue. While stores like Walmart and Target are investing in stores that make shoppers experiences pleasant, SHLD is minimizing spending.

The one ace in SHLD is the real estate value of their 2700 stores in USA and Canada with 250Mil square feet of space. Many articles have touted this, including the 2007 Barron's article. The market speculated that Lampert planned to monatize the real estate when he first merged Sears and Kmart. But that did not play out. Instead Lampert first tried various retail concepts, Sears Essentials, Sears Outlets, novel store formats, etc. But they all performed mediocre at best. And then the 2007 recession hit. Last year, sales lagged to the point where Lampert agreed to sell 11 stores for $270Mil and also close another 120 stores.

Lampert clearly wanted to make retailing work, but on his terms. And his experiments met with disappointment, he then tried to unlock the value of his holdings by spinoffs and store sales.

I think Lampert has done a decent job of being a capitalist. Although investors who ride with Sears Holdings, like myself, may have been disappointed, he does what he needs to do to further his wealth. 1/3 of the company's float is short. That means a large segment of the the market is counting on Sears to go bankrupt. I do not for a minute believe that will happen. I believe Lampert's share of Sears will appreciate. But I also believe Lampert will allow the Sears brand to keep sliding. Meanwhile, all of us shareholders have no say in Sears, except Lampert, and I am very unclear as to what he will do next. His letters to shareholders do indicate that he is a committed retailer but gives little hint as to a long term exit strategy. I don't believe he will cheat us minority shareholders, but SHLD is too unpredictable for my taste. So over the years I have gradually sold off all my shares. I have about broken even now. And I only keep my remaining shares to avoid a tax gain.

Disclosure: As well as owning SHLD, I have in the past received shares of OSH in their spinoff. I have sold those. I also recently received SHOSR shares — SHOSR are rights to purchase the future spinoff of some Sears stores under the ticker SHOS — [update] I found out I couldn't trade SHOSR anymore so I did the next best thing, I exercised my right to buy the SHOS shares at $15 and I intend to sell SHOS as soon as I receive them.

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