It is a question I always struggle with when it comes to Sears (SHLD), as the who's who of value investors have taken significant positions in SHLD. Lets run down the list:
- Bill Ackman; SHLD represents 46% of his portfolio
- Mohnish Pabrai; SHLD represent 13% of his assets
- Bruce Berkowitz; SHLD represent 9.5% of his portfolio
- Martin Whitman
- Whitney Tilson
- And many others to list
So let us look at some fundamentals of the business.
As a retail investment I do not think SHLD is sound for many reasons.
First, the shopping experience is not very attractive. I find myself not motivated to go to SHLD for anything to buy. And when I wander into the store I feel very depressed; it gives me the feeling of old and tired. Moreover I find some of their merchandise in same manner as my overall impression of the stores that is old and tired. I opt to shop at other retailers and I have no doubt you would to. Ask yourself the following:
- Do you drive past Macy's to shop for clothes at Sears?
- Do you drive past Best Buy to shop for TV's at Sears?
- How many people pass up driving to Costco, Walmart or Target to shop at K-Mart?
Second, the business economics is not that good. Sears inventory days have been creeping up over the years and that is not a good sign for retailer to hold older and older inventory. Holding to inventory drives your costs up, slows your cash conversion cycle and makes your merchandising less relevant.
Third, retail turnarounds are notoriously hard and long and have low probabilities of success. Actually as a rule of thumb never invest in a retail turnaround story as you can earn better returns elsewhere.
I doubt that most of those investors who hold SHLD missed some of these points. However I think they are not in it for the retail business. So the question is, is it a matter of faith in Eddie Lampert, who is undoubtedly a brilliant money manager?
He is very accomplished and has a proven track record that will silence lots of his critics. He turned his mere investment of $900 Million in K-mart to $6.7 billion by taking K-mart from bankruptcy and merging it with Sears to create SHLD. He is currently using SHLD cash to buy back stock to increase his ownership in the company and its underlying value. But do you invest on faith alone?
Real Estate and Brand Value
A lot of loyalists are expecting a similar feat in monetizing SHLD real estate and its brands. SHLD has taken steps to do that by reorganizing itself along those lines, which I like very much. Several investors in Sears highlight the primary drivers of Sears value as:
- the underlying value of its real estate,
- the value of its brands, if sold to third parties: Kenmore, Craftsman, DieHard...etc,
- the cash that the retail business can earn over the next five years, and
- the potential returns on that cash that Lampert can generate over the life of the investment.
- Sear's Free Cash Flow that the retail business generates going forward. The TTM free cash flow is $949 Million. Its Present Value, assuming no growth or decline and Cost of capital of 10%, is: $9.5 Billion,
- The value of the firms underlying real estate is: $4.7 Billion,
- The value of the firm's brands: $3.4 Billion ( Book value of its trademarks), and
- Lamperts magic to reinvest the free cash in attractive opportunities is: Priceless.
The estimates above are conservatives as real estate has appreciated some from the time of purchase and will be worth more once the credit and real estate issues are resolved. Also, the brands value of $3.4 is a conservative estimate that can go much higher is sold or monetized through licensing agreements.
I still need to do more homework but at roughly the $97 a share that SHLD shares are currently offered for, and possible turnaround in its retail operations, SHLD looks more and more as a value idea that needs a long term viewpoint that will likely generate good returns over the next 3-5 years.