Sears Isn’t Ignoring the Retail Operations After All

Critics of the Sears and Kmart turnarounds have long argued that if Sears Holdings (SHLD) Chairman Eddie Lampert ignored the retail business by cutting capital expenditures and marketing expenses, the company would begin to die a slow death. Well, the skeptics have proven to be very wrong, as shown by the stock’s move from $15 several years ago to nearly $180 today.

After the bell on Wednesday we learned that Sears has hired John Walden, an eight-year veteran manager from Best Buy (BBY), to become Chief Customer Officer, with core responsibilities including customer-focused strategies and new business development. Such a move certainly doesn’t seem to imply that Lampert and Co. are not focused on the retail operations.

This is not to say that Sears will become Target (TGT) or Wal-Mart (WMT), because the window for that opportunity has long been closed. However, if they can earn similar profit margins to other large retailers over the next several years, the earnings power of the company will be much higher than it is today.

Full Disclosure: Long SHLD at time of writing

 

Sears Holdings Issues Upside Guidance

Sears Holdings (SHLD) projected fourth quarter earnings well above consensus estimates Wednesday. The company estimates EPS for the period will be in a range between $4.87 and $5.39, well above estimates of $4.86 per share. Despite reports in the financial press that sounded much more gloomy about the company’s core retail business, real estate sales and derivative contracts are expected to contribute only 8 cents to earnings for the quarter.

Chairman Eddie Lampert has decided against share repurchases for the period, which will result in a cash balance of $3.5 billion, or $23 per SHLD share. What exactly he will use the cash for is still unknown, but many are speculating that a lack of share repurchases in Q4 signal that other uses for the money are far more likely in coming months. That seems like a very reasonable assumption.

Shares of SHLD rose 3.5% on the pre-announcement, to $172 per share, but it still appears to be attractively valued. Full year earnings should come in around $9.38 per share, putting the stock’s trailing P/E at around 18. With 2007 earnings expected to jump more than 20 percent, a below-market multiple for Sears stock seems quite low. As a result, it remains a large long position of mine.

Full Disclosure: Long SHLD

Sears Holdings Drops 5% After Earnings

It’s the same old story with Sears Holdings (SHLD). In fact, I feel like I’m just repeating myself a lot. However, I have long been positive on the stock, and it is one of Peridot’s top five holdings, so rather than ignoring it just for the sake of not sounding repetitive, I will likely continue to share my views on the company and the stock’s investment merit.

In case you missed it, Sears reported Q3 earnings of $1.27 per share and sales of $11.94 billion. The revenue number was at the high end of estimates, and the earnings number included investment income of 42 cents per share. Excluding one-time charges and investment income, earnings did miss consensus estimates, which caused the sell-off in the stock.

Comments on the quarter across Wall Street were very predictable. Same store sales were down, which is bad and must be turned around at some point. Earnings were up on cost cutting, but such moves can’t be maintained forever. Most analysts are ignoring the investment income when looking at the quarterly results, because they are unrelated to operating activities of the main retailing business.

It is my view, however, that ignoring the investment income is a mistake for investors. If an investment in Sears stock was merely a bet on the retail operations, then I can understand not caring about profits derived from investing excess cash. However, a large piece of the investment thesis behind SHLD has been, and will continue to be, Eddie Lampert’s ability to allocate excess capital in order to earn returns that far exceed those of the retail business. There is a reason he changed the name of the firm to Sears Holdings. It’s a holding company. There is more than just retail here.

Investors who are in Sears merely for the retail operations should probably move on to something else. SHLD will continue to report declines in same store sales and grow profits via cost cutting, share repurchases, and investment income. This will ultimately lead to a tremendous increase in shareholder value.

If, however, you are like me and are investing in this stock for the entirety of the operation, then you should stay with it despite today’s decline. Sears is a holding company and will continue to boost shareholder value via multiple ways. In fact, as the company finds new avenues for allocating capital, they will become less and less reliant on Sears and Kmart than they already are. While this will draw criticism from many, especially retailing analysts, the end result will be a rising share price, which is really all that matters to me.

Full Disclosure: I own shares of Sears Holdings personally, and my clients do as well.

 

Taking Some Profits in Coach, Among Others

With the recent market rally we find ourselves within 1% of the previous highs on the S&P 500 index. I am beginning to trim positions a bit here into the strength. I am fully aware that this move could backfire given that we are heading into a seasonally strong period for equities, but as we once again near the top of the trading range, I feel it is prudent to tread more carefully.

What have I been trimming exactly? A couple of areas. First, asset managers. These stocks have been strong with the market doing well. Since they track the overall direction of the indexes over the short term, they seem to be ripe for selling if I’m right and the market is closer to the end of the rally than the beginning of it.

I have also been selling much of the Coach (COH) stock that I alerted readers to in the $25 area. The stock has soared, along with other consumer discretionary names. At more than $33 per share, we’ve seen a 30% jump in a very short amount of time. The stock now trades at 20 times forward earnings, about in line with their projected 15-20 percent growth rate. While the stock is not overly expensive here, the value proposition that got my attention has largely been corrected with the recent rally.

All in all, I urge investors to tread carefully now that we have gained much of the losses back from July and August. I have a tough time justifying a 2007 target on the S&P 500 of more than 1,400 at this time. This leaves us with about 6% upside in that scenario. If that is the most I could miss by raising some cash here, I don’t think I’ll be doing anyone any great harm by shifting some funds away from equities and into more income-related securities.

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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