Sears Contemplates Next Act

Sears Holdings (SHLD) received a lot of attention when it announced that it would not offer any guidance to Wall Street whatsoever. They don’t even host conference calls to discuss quarterly financial results. I don’t know of any other large cap company that doesn’t host at least four calls a year. As a result of the lack of transparency, only a handful of analysts cover the stock.

Based on their track record, it was very interesting to read the company’s press release last week detailing their second quarter results. Buried toward the end of the unusually lengthy release was a section entitled “Investment of Available Capital.” Below are a couple of excerpts:

“The Company has also repurchased $1.1 billion of its common shares since the merger and expects to continue to repurchase shares subject to market conditions and board authorization. In addition, the Company may pursue investments in the form of acquisitions, joint ventures and partnerships where the Company believes attractive returns can be obtained. Further, the Company may determine under certain market conditions that available capital is best utilized to fund investments that it believes offer the Company attractive return opportunities, whether or not related to its ongoing business activities.”

“Our strong financial position and cash flow generation provide us with the flexibility to capitalize on a wide range of market opportunities as they arise. In addition to investing in our business and acquiring our shares, we are prepared to invest substantial amounts of capital if we identify other attractive investment opportunities which have the potential for returns we believe appropriately compensate the Company for the associated risks.”

The significance of these statements might not be obvious at first blush, but you need to take into account that this is a company that keeps everything very close to its chest. They rarely offer a glimpse into their strategy. Heck, for years the media has been reporting that the Sears/Kmart deal was about real estate. When was the last time they did a real estate deal.

To me it’s pretty clear why, for the first time, Sears has chosen to tell investors a little but more about their plans. They’re going to do something, and it’s not necessarily going to have anything to do with Sears or Kmart. And it might not make any sense whatsoever when it happens. After all, everybody thought Lampert was crazy buying Kmart in bankruptcy and swapping his debt for new equity at $15 per share. Well, that $15 stock that nobody wanted to touch went up 11-fold in only a few years.

I have no idea what he has up his sleeve this time, but I’m very interested and I don’t think we’ll have to wait too long to find out. Stay tuned.

Where is this Consumer Carnage I Keep Hearing About?

Many of my comments in recent weeks have centered on the consumer sector. The reason is pretty simple. Most people have been recommending investors shun consumer discretionary names in their portfolios, and the stocks have indeed reacted to the fear of a slowing consumer by getting absolutely decimated. Now, with many of these retail related business reporting their second quarter results in August, and issuing outlooks for the second half of 2006, it is becoming clear that, just as I have been suspecting and writing about for some time, sentiment seems to be unfairly negative as far as consumer spending is concerned.

Aside from Wal-Mart, retailers like Target (TGT), Kohl’s (KSS), JC Penney (JCP), Federated (FD), and Coach (COH), to name a few, have reported very good results. Last night Abercrombie and Fitch (ANF), a Peridot holding, raised guidance for the second half of 2006 and the stock is up nearly $7 per share today.

The takeaway point here is that even though the housing market is soft, interest rates have risen substantially, and gas is north of $3 per gallon, the U.S. consumer is not going into hiding. Gas prices were over $3 this time last year, interest rates are still not extremely high compared with historical averages, and most people don’t have adjustable rate mortgages or rely on investment properties for income.

There is no doubt that the lower end will struggle to make ends meet more-so than others, and Wal-Mart’s lackluster results shows evidence of that. However, if you focus on areas of consumer spending that won’t be adversely affected as much, namely the high end and the teenage segment, stock prices could do very well despite all of the people out there warning of impending doom.

A Coach Follow-Up After a Strong 2Q Report

Last week I mentioned luxury products maker Coach (COH) as a badly beaten down consumer discretionary play that I thought was looking awfully cheap after a 30 percent correction. The company reported an excellent quarter this morning (EPS of 31 cents, 2 cents ahead of estimates) and issued 2007 guidance of at least $1.55 per share, representing growth of 22% year-over-year.

Where does this put fair value for the stock, which was at $25+ a week ago and now is fetching north of $29 in pre-market trading? I think more upside is ahead. Since Coach’s fiscal year ends in June, investors should adjust the company’s profit guidance to a calendar year projection. That puts 2006 EPS at $1.41, followed by $1.69 in 2007.

In a strong bull market, companies growing at 20%-plus can garner price-earnings ratios of 30 fairly easily. In this market environment though, that is a pretty aggressive assumption. I think COH shares should be valued at no less than 25 times earnings, but with a lot of people jittery about the consumer discretionary sector right now, we can use a valuation range of 20-25 times earnings to be overly conservative.

If we use a 25 P/E on 2006 numbers and a 20 P/E on 2007 projections, fair value on Coach shares is in the $34-$35 area. So, even after a 15% gain since last week, we still have some room for further upside in the stock.

Despite Headwinds, Consumer Discretionary Sector is a Solid Contrarian Bet

Over the last few months retailers have had a tough go of it. Even companies that continue to hit their numbers have seen their stocks fall by 30% or more. We all know the bearish arguments for the consumer discretionary sector. Higher interest rates, flat real wage growth, high gas prices, ARM’s adjusting for many home owners, etc.

While I agree these are all issues facing the U.S. consumer, I don’t think we should slash every consumer discretionary company’s stock price by a third. One must be selective, but there are companies out there that aren’t doing as poorly as their stock prices indicate, and shouldn’t later this year or next year either.

Take for instance the upper class high end consumer. Are these issues going to adversely affect them to a large degree? I’d argue that $3 gasoline and variable rate loans will squeeze the low income earners a lot more. They are the people who took out the interest-only or 3/1 ARM mortgages because it was the only way they could afford the house they wanted to buy. A tank of gas going from $30 to $50 is not going to crimp the richest 5% of America.

Moving to a company specific situation, consider the luxury goods maker Coach (COH). I started buying the stock recently at $25 and change and it’s the first time I’ve ever even considered buying shares. The stock traded at 25 or 30 times forward earnings whenever I looked at it. Even a 20% growth rate couldn’t convince me that it was a bargain at those levels.

The company has continued to hit its numbers and I expect more of the same when they report in early August. However, the stock took a dive along with the other retailers. Down from a high of $37, the stock traded at about 18 times 2006 estimates of $1.39 per share. Twenty percent growth in 2007, which I think is very doable despite the economic climate, puts the forward P/E at 15. While still a market multiple, a high end luxury goods leader like Coach looks attractive at such a price and even has $2 in net cash on the balance sheet.

I also want to mention a long time favorite, Sears Holdings (SHLD). Along similar lines, SHLD shares are down $30 from the highs set after they blew out first quarter estimates. Since the company is benefiting more from a turnaround in operational efficiencies, as opposed to shoppers banging down the doors at their stores, I expect another solid quarter when they report next month. We could very well get a post-report pop in the stock if such a scenario plays out, making the $30 correction look quite silly in hindsight.

Do Nardelli’s Actions Warrant Selling Home Depot?

Home Depot’s recent annual meeting went pretty horribly if you are a shareholder. For CEO Bob Nardelli, it probably went pretty well. He refused to answer any questions, didn’t reveal the results of the shareholder votes, and after 30 minutes he bolted for his private jet. None of the other board members were there because Nardelli told them to stay home.

Now I don’t own Home Depot stock personally, or for my clients, but a lot of people do. Should investors sell the stock after these recent developments? After reading about how Nardelli ran the meeting, I want to say “yes.” However, the stock is pretty darn cheap. That doesn’t mean I would give it a ringing endorsement. After all, Nardelli’s recent actions sure do smell of guilt (of what exactly, I’m not sure, maybe excessive pay, maybe just embarrassment). Trading at 11 times fiscal 2007 earnings, HD shares seem to have limited downside from their current $37 quote.

Share price valuation aside, should his excessive compensation scare investors off? To me, this issue is very difficult. Is Nardelli worth $120 million over 5 years? Of course not. But is Alex Rodriguez worth $250 million over 10 years? Doubtful. These two men are essentially being paid the same amount to do their jobs and the average American finds compensation like this to be completely unfair.

In the baseball world, salaries are determined by what the market will bear. Since fans are willing to pay money to see athletes play, paying them high salaries can actually result in the team earning a profit, so the high salary is “worth it” to the team owner. It’s the market-based economy. It’s capitalism.

Is A-Rod’s job more important than a school teachers’ job? Not at all. However, there are many more people who can teach than can play all-star caliber third base, and nobody is willing to pay $50 to watch someone teach a math class for three hours.

Now I’m not saying A-Rod deserves $25 million and I’m not saying that school teachers don’t deserve to earn more money. But, since how much someone makes is not up to me, I have to simply understand why the system is working the way it is.

As for executive compensation, it is a much more difficult issue to tackle. How much is Bob Nardelli worth to Home Depot? I have no idea how we can begin to figure this out. Therefore, I have no idea how much CEO pay is fair. Are chief executives in this country overpaid? Absolutely. But what is the right number? I just don’t know.

I can tell you one thing, though. In my opinion, stock price performance should not be the only determinant of executive compensation levels. Many are saying that the fact that Home Depot stock has fallen since Nardelli took over in late 2000 proves that he is overpaid. I have to take issue with this.

In Nardelli’s first five full years as CEO, it is true that the stock fell 8%, from $43.88 on 01/01/01 to $40.33 on 12/31/05. However, such poor performance is Nardelli’s fault. Sales during those five years rose 52% to $81.5 billion. Net income and earnings per share fared even better, rising 93% and 111%, respectively.

The poor performance of HD stock is simply due to the fact that the stock was overvalued in 2001, trading at 34 times forward earnings. Investors who bought shares then and lost 8% over the subsequent five years have nobody to blame for that except themselves.

All in all, Bob Nardelli has done a very good job running Home Depot. The only problem is, we really don’t know how much that is worth to the company’s shareholders in terms of compensation. All we know is that $120 million sounds like a lot when the median family is America earned less than 1/500th of that amount during the same period.

Sears Bears Get Hammered… Again

The bears on Sears Holdings (SHLD), and there are plenty of them, are again getting crushed today. This marks the second straight quarter that shares of SHLD have spiked after posting blowout earnings. As I have been telling everyone since the Sears/Kmart merger closed, Eddie Lampert’s strategy for the company is working, despite negativity from retail analysts that still haven’t a clue.

Sears Holdings stock is jumping $17 this morning, for a 12% gain. Their first quarter earnings were even better than wildly bullish investors like myself could have hoped for. Earnings came in at $1.14 per share, a stunning $0.50 above the consensus estimate of $0.64 per share. Here’s the nail in the bears’ coffin; same store sales for the period dropped 4.8%!

The bearish case, which has been laid out by retail analysts on CNBC and in newspapers and magazines nationwide for months, has been that without positive comp store sales and increases in market share, Sears would get eaten alive by Wal-Mart (WMT) and Target (TGT), and their stock would tank as a result.

As I’ve said before, and I’ll say again, the company is not trying to increase same store sales, or overall sales. They care about one thing and one thing only, profits, because they know that over the long term profits are the only thing that matters if you want a stock price to go up. If today’s blowout numbers don’t back up this theory, I don’t know what does.

Sears Holdings is one of Peridot Capital’s largest holdings and will continue to be, despite today’s $17 move higher.

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*UPDATE* 1:59pm

With Sears stock now up $21 on the day, I realized I forgot to mention one thing in my original post. Check out the SHLD share repurchase plan. During Q1 2006 they bought back 3.3 million shares for $413 million. That comes out to $125.65 per share. The stock is at $159 right now. They know what they’re doing, on so many levels. Okay, my cheerleading is over… for now anyway.
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Sears Ups Buyback Program to $1.5B

Sears Holdings (SHLD) announced today that its Board of Directors has approved the repurchase of up to an additional $500 million of the company’s common shares. This authorization is in addition to the $30 million worth of shares that remain available for repurchase under the $1 billion share repurchase program previously announced. Since initiating that program in Sept. 2005, Sears Holdings has purchased approximately 8.0 million of the company’s common shares at an average cost per share of $120.86.”

That is the first paragraph of a Sears Holdings press release issued Wednesday morning. One of the most attractive aspects of owning Sears stock is the fact that as of December 31st they had $4.44 billion in cash on the balance sheet, which equates to $28 per share, or more than 20% of the company’s equity value. Share repurchases are one of the main tools Eddie Lampert and Co. will use to convert store cash flow into higher earnings per share, which will subsequently create quite a lot of shareholder value.

Unlike Cisco (CSCO) and Intel (INTC), they aren’t buying back stock when it is overvalued just to cover up options dilution. Rather they are buying it because it is undervalued and they have a pretty good idea that their average cost per share will be below market prices several months later.

Another Blowout Quarter at Sears

Long time readers of this blog know that I’ve been bullish on Sears Holdings (SHLD) for a long time. I’ve repeatedly made the case that bears focusing on same store sales were missing the point. Chairman Eddie Lampert’s strategy with prior retail endeavors, as well as with Sears Holdings, has been to not focus on overall sales, but rather on profitable sales.

Sears’ financial results have shown that this strategy is coming to fruition, but the bears have been winning with SHLD as of late. In fact, the stock has been amazingly range bound for months, hovering between $115 and $125 per share, as the chart below shows. Despite the pattern of higher than expected profits, the stock has been stuck. It manages to open higher after posting quarterly results, only to see the gains vanish by the end of the day.

This morning Sears reported fourth quarter earnings of $4.03 per share, 41 cents ahead of estimates, which stood at $3.62. Again we see the stock rallying in pre-market trading, rising $9 right now to $126 per share. If the recent past repeats itself, the stock won’t hold those gains and will continue to trend in its narrow trading range. This result would not be surprising if we continue to hear about falling sales.

However, I am still holding out hope that today’s gains hold and we get a breakout above $125. It’s amazing to me that the company is purposely trying to reduce sales by only selling products that they can earn a profit on, and yet when they deliver such results, people complain of market share losses.

Investors need to realize that over the long term earnings drive stock prices. If sales were all that mattered, not profits, then the Internet bubble never would have burst. Consider how many dollar bills I could sell if I only charged 95 cents for them? My sales would great, sure, but my stock would be worthless without profits.

A.G. Kicks Abercrombie While It’s Down

Despite today’s downgrade from “buy” to “hold” by A.G. Edwards (point “B”), I still view the recent weakness in shares of Abercrombie and Fitch (ANF) as an excellent entry point for investors. As you can see from the chart below, A.G. has hardly been adept at calling the direction of ANF stock. They put the “buy” recommendation on it in June 2005 (point “A”) and within weeks the shares began a freefall from over $70 to under $45 in less than two months. If I’m right that Abercrombie will rebound later this year, this will be just another example of analysts urging clients to buy high and sell low.

Urban Jumps 12% on Analyst Comments

Two weeks ago I wrote that Urban Outfitters (URBN) looked like it was bottoming at $25 and change, given that it was oversold and yet was holding a heavy support level around $24.44-$24.45 per share. The next week, on January 4th, the stock closed at $24.48 and never went any lower.

Today we have a couple of positive analyst reports pushing the stock up more than $3, or 12 percent, to $28 and change. Traders can take their $3 and run, but I would not be surprised if we see $30 this month.