Why I Bought Sears Holdings and Promptly Sold It

Sears Holdings (SHLD) and I go back to late 2007, when I read the famous bullish Barron's article. After I read the article, I got the stock at $135 per share. Later, I managed to average down in the following year. I sold out the last of my position last year, and overall probably broke even. Last week, the stock hit a recent low when CEO Eddie Lampert announced he would lend Sears $400M for a short term through entities that he controls. That piqued my interest in the company again. The stock reached a low of $24.50 last week. From the time when I first bought seven years ago to now, they have spun off Sears Hometown, OSH, Sears Canada and Lands End to shareholders. I have heard people estimate these spinoffs at $23 per share. That means the stock has dropped 64% from when I first bought.

As the original Barron's article suggested, it is the real estate and other assets that makes SHLD attractive to investors. SHLD owns or leases about 2000 locations in the US. Sears also owns the Kenmore, Craftsman and Diehard brands. The company also operates the Sears Auto Centers. But in the last seven years we have not really seen any large-scale monetization of the real estate. The company has closed hundreds of stores because of underperformance. In the process, the company may make a gain on the sale of the real estate or on the sale of the lease if the store is not owned. Right now, the company's equity is less than $1 B and it has lost more than $5 B in the last 3 years alone!

So the company's income and balance sheet steadily declined over the last 7 years. No wonder then that the company stock has dropped 64%. Even if investors believed in the real estate story, it is very unclear how long it takes. And many gave up, myself included. But in investing, I can like any security at the right price. And I like SHLD at $24.

In my analysis, I am trying to be objective. Bad mouthing Eddie Lampert or being hysterical doesn't serve much purpose in making the correct decision. As I mentioned earlier, Sears has shed several businesses that it owns. Sears is still left with its main assets which has the most optionality. The following summarizes Sears' real estate associated with their full-line stores only and shows their change over the last two years.

Date	No. of Stores	Total Sq ft (mil)	Owned vs. Leased
Sears Domestic 2012	867	116	60%
Kmart 2012	1305	125	16%
Sears Canada 2012	122	16	11%
Sears Domestic 2014	798	109	60%
Kmart 2014	1221	115	16%
Sears Canada 2014 (prorated 51%)	59	8	11%

The company has gradually been downsizing. In the process it had gains of $0.67 B and $0.47 B and $0.06 B in 2013 2012 and 2011, respectively, from property sales or sale of leases. The company also closed 145, 60 and 247 stores in 2013, 2012 and 2011 respectively, at a cost of $0.14 B, $0.16B and $0.34 B respectively.

Because Sears is bleeding money so badly the company is openly discussing harvesting the real estate value. The consensus view is that the company will have negative operating cash flows between $1B - $2B per year. The CEO resorted to lending the company $400M because of this urgent need for cash. Whatever the CEO was trying for the last seven years to revive the company has proven to be a failure. The is no other out for the company but liquidation or major downsizing of the Sears' retail business. The following lists Sears' financial position and how I estimate it would fare in a liquidation.

	Value (bil)	Total value (bil)
Market cap	2.6	Total EV: 18.3
Long-term debt	2.8
Pension and other liability	4.7
Current liability	8.2
Inventory and current assets	8.4	Liquidation value: 20.7
Sears Canada	0.5
Trademarks	1.8
Store Real Estate	8.5
Other Property	0.5
Auto Center	0.5
Home Warranty & Repair	0.5
Difference		2.4

I used $8.5 B for the store real estate because that is a number I've heard floating around. That means the company can realize a gain of about $4 M a store or $40 per square feet. The above also does not put any value on Sears online though Sears is the third biggest online retailer today! So the reader may argue that I am being too conservative, but that's my nature. And to me the overall $2.4 B potential gain is too small a margin considering it is bleeding so much cash everyday. Also there is just so much unknown regarding value of the company's real estate. Are the remaining store locations more or less valuable on average versus the hundreds that were closed before? A retail investor like me simply does not have the resources to research the answer.

With that in mind, who is backing the company becomes a major consideration for me. The company is owned by three of my most respected value investors: Eddie Lampert, Bruce Berkhowitz of the Faireholm Fund and David Chou of the Chou Funds. Berkowitz and Chou have two of the best track records over the last two decades in the USA and Canada. And both of them have a sizeable 10% position in their funds.

So, there I was on Friday, thinking about the issues with SHLD. I also reminded myself that I spent more money at Sears than any other retailer in recent years — mostly for appliances and at the Sears Auto Center. I then decided to reopen a position. However, I hadn't completed this blog entry and I didn't have the entire analysis clearly in mind. When I completed this entry during the weekend, I reconsidered my purchase and thought that the problems outweighed the potential upside. By Monday, I decided to put SHLD in the too-hard pile and sold my position.

This was a small mistake that didn't harm me, thankfully.

A Tale of Two Retailers: PETM and SHLD

Petsmart (PETM) recently announced very impressive earnings. The company earned $0.75 a share vs $0.50 the same quarter a year ago. When a company earnings rises by 50%, it earns a high P/E multiple. The expected P/E for the current year is 20. The company's revenue rose 9%.

PETM is the country's largest pet retailer; the company has 1,200 stores. It is unclear to me how much more it can expand. On top of that, I heard Jim Cramer of CNBC has been touting PETM all year. Jim Cramer is as big a contrarian indicator as I have seen. When he says buy, I hear sell! I really want to unload PETM but now that it is up 2.5x, but I am reluctant because of capital gains.

While PETM is flying high, Sears Holdings (SHLD) is going in the opposite direction. The company's sales declined yet further in the most recent quarter. Comparable store sales was down 1.6% for Sears and 4.8% for Kmart. The company lost money yet again but it does not have liquidity problems. I trust Eddie Lampert to keep the company afloat and extract the most value. They have recently spun off Sears Hometown and Outlet and then Sears Canada in two transactions. Despite Eddie Lampert saying repeatedly that he didn't invest in Sears to sell its real estate, he is selling the company piece by piece to unlock value. When just the core Sears is leftover he just may shutter the best locations and sell their real estate. That's fine by me, but many would feel sad to see the decline of an iconic retailer.

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Disclosure: I am considering selling some PETM and my Sears Canada position but I haven't made up my mind.

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.

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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.