Late Friday Sears Holdings (SHLD) announced that its board has authorized a $500 million stock buyback program. You may recall the company did the same thing exactly a month ago on September 14th. In today’s press release, Sears said they have bought back $434 million of that inital amount in the last month, at an average price of $118.86 per share.
This announcement brings the total amount of the buyback to $1 billion, or roughly 5% of the company’s outstanding shares, and could be completed within 60 days, start to finish. Based on these numbers, earnings per share for Sears in 2006 will be increased by nearly $0.40 per share.
Amazingly, the stock still goes down pretty much every day, and trades below the prices Sears has been paying recently. Investors won’t be able to come back a year or two from now and say they didn’t have a great chance to get in, that’s for sure.
There are certain companies that seem to have a huge profit miss and a resulting stock price catastrophe every so often. Fossil (FOSL) is a perfect example. This company is used to seeing its equity get crushed every few quarters. Investors who are willing to pounce can get a terrific price and wait for a rebound to sell for a nice profit.
Fossil, a leading maker of watches, once again has seen its stock drop from a 52-week high of $32 all the way down to below $20 per share, for a haircut of about 40 percent. Estimates for 2006 earnings are nearing $1.50 and the company has almost $2 per share in net cash on its balance sheet. The result is an enterprise value-to-earnings ratio of only 12x for a company that is growing double digits.
This most likely isn’t a stock that investors should buy today and hold for 3 to 5 years, given its history of putting together a few good quarters and then giving back the gains. Nonetheless, buying at these levels should give investors some upside as the company delivers on reduced expectations. When should FOSL be sold? I think a rebound of 25 percent is in the cards, so Fossil could see at least $25 per share in the next 6 to 9 months.
With the stock of Sears Holdings (SHLD) down 25 percent from its high, concerns are mounting, good news goes unnoticed, and sentiment has waned. Why then am I still bullish? Why is this the third time I’ve mentioned SHLD this month? Don’t worry, in the days and weeks ahead I will try to move on from talk of Google, Sears, and the airlines and explore some new companies.
Let me throw some numbers out there that show why I feel SHLD shares at $120 are a steal. After this, I’ll try and stop talking about it so much. Current estimates for 2006 call for Sears to earn $7.88 per share on $56 billion in sales. This equates to a 2.3% net profit margin. I happen to think this margin projection is too low. The way I see it, the best two comparables for Sears are J.C. Penney (JCP) and Federated (FD). After all, the Sears model is moving toward Sears and the newly created Sears Essentials stores, which very much will be traditional department stores.
Now, let’s look at consensus estimates for JCP and FD. For next year, JCP is expected to earn $4 on $19.5 billion in sales, with FD slated to make more than $5 per share on $16.6 billion. Both of these estimates come out to a 5 percent net margin. Call me optimistic, but I think the turnaround at Sears should net margins very close to JCP and FD. There is no reason to think a solid management team cannot attain department-store-like margins.
It is possible that Kmart was so screwed up that it is beyond repair, at least to get to the same level of profitability as these other stores. For sake of being conservative, I’m going to assume SHLD can get to a 3% profit margin by the end of 2006. Since the Sears model is going to be to sacrifice sales in order to boost profits, I’m going to combine my 3% margin estimate with $55 billion in annual sales, one billion dollars less than analysts currently expect. All of the sudden, SHLD is earning $1.65 billion per year, which makes for an easy calculation with 165 million shares outstanding; that’s $10 per share in earnings.
At $120 per share, the stock is only 12 times these profit estimates. And remember, this model does not include the $900 million cash Sears will get from Sears Canada, the $500 stock buyback program recently announced, or any real estate sales of any kind. There is a lot of upside here, and while it is by no means assured, given the recent negative sentiment and a 25 percent drop in the share price, SHLD looks very attractive. Just imagine if SHLD can ever get to a 5 percent margin, that would get us to nearly $17 per share in EPS. Put a market P/E on that and you get a stock price of $250.
After recommending investors buy Northwest Airlines (NWAC) stock at $5.00 less than a month ago, today Bear Streans downgraded the stock to a sell, after yesterday’s bankruptcy rumors sent the stock down as much as 60 percent to $1.57 per share. Amazingly (well, maybe not given this analyst’s track record) NWAC stock is up 25 percent today as some investors bet Northwest will temporarily avoid filing Chapter 11 this week by using that possiblity to reach an agreement with its mechanics on wage consessions. It would be hilarious if Bear’s sell call marked the bottom in NWAC and the stock actually rose significantly after news of a deal. At that point, Bear would probably upgrade the stock just in time for the company to file bankruptcy.
Although the stock isn’t really reacting to the news, Sears Holdings (SHLD) today announced a $500 million stock repurchase plan. This represents 2.3% of the company’s total shares outstanding. These are the kinds of things SHLD management will do to enhance shareholder value through the use of its free cash flow. They will not use the money to mimic other retailers that open new stores. Rather they will try and increase the profitability of existing stores and use that money to boost the stock price.
Just a few months back the retail sector didn’t look all that tempting. Valuations had gotten fairly lofty by historical standards. Department stores like Federated, May, and J.C. Penney traded at market multiples when they traditionally price at a discount. Apparel retailers like American Eagle and Abercrombie, often thought of as fairly volatile to due the fickle nature of teen fashion, fit into the same category; sitting at the upper end of their historical valuation ranges.
Now with oil in the high sixties and Hurricane Katrina having ripped through the Gulf Coast, retailers have been hit fairly hard. As with any short-term downward pressure on Wall Street, opportunities come out of the woodwork. Wal-Mart, for the first time in years, now trades at a discount to the S&P 500. Abercrombie and American Eagle do too. Sears Holdings, after being unconventionally quiet for months since the Kmart merger, has been drifting down for a while (they report earnings on Thursday, so we’ll get more color on that situation shortly).
Several less well known retailers also have felt the heat, and often get hit more since small and mid cap stocks tend to be more volatile due to less predictability in their business trends. There is no doubt that high fuel prices are hurting lower income consumers, but growth retailers should be able to sustain the headwinds longer term. As far as the sector goes, investors should be worried when others are confident, and as is the case right now, confident when others are worried.
Via the link below you will find archives of two conference calls held this month by Overstock.com (OSTK) along with a slideshow to go along with each. I suggest listening to the Q2 call first, then the one about the lawsuit, in order to get a full understanding of what’s going on. Entertaining is an understatement. They will also help you understand why 52% of OSTK’s float was sold short as of July 12th, and you can’t borrow any shares as of today.
This morning’s initiation of coverage on Sears Holdings (SHLD) by Morgan Stanley could prove to be one of the worst analyst calls of the year. I can understand people who doubt the viability of combining Sears and Kmart in order to turn the franchises around. As an analyst though, I would suggest those bears simply stick a neutral rating on the stock and highlight the risks that go along with banking on this combination.
Slapping a sell on this stock, even at $150 per share, is a very risky proposition and could make the retail group at Morgan look like idiots if certain things go right. The basic premise for the sell rating is that Morgan feels Sears Holdings can not be fixed. That’s a fair view, but I think you should at least give them a chance before pronouncing the company dead. The merger just closed and they haven’t even had a chance to implement their strategy yet. Those plans are just beginning and could take until 2006 to bear fruit.
There are many catalysts that could send this stock higher over that time. There will be real estate sales. After all, there are Kmart and Sears locations next to each other throughout the country. Retailers like Costco (COST) are struggling to find new store lots and when they do, it takes several years to get permission to build on them. That’s how extra off-mall real estate becomes valuable.
Sears Holdings also hasn’t announced anything about Sears Canada or some of their other divisions that don’t fit in with the main strategy. What will happen with Lands End or Orchard? They have $1.6 billion in cash and a lot of debt outstanding that can be retired early. All of these catalysts are unrelated to reinvigorating the core brand, but matter very much to the value of the business, and the share price.
Sticking your neck out and recommending purchase is a gutsy call (but one I’m willing to make), especially when the stock is up 10-fold since emerging from bankruptcy. However, I think putting the rare sell rating on this stock will prove one of the worst analyst calls of 2005 when we look back on this years from now.
Shares of Sears Holdings (SHLD) are down about 5% today after reporting quarterly earnings of 65 cents per share, two cents ahead of estimates. Without news of any real estate related deals, the combination of a 1 percent profit margin and same store sales down year-over-year aren’t making investors too excited today. Even still, if you haven’t gotten into this stock yet, this is an opportunity to do so in the 140’s.
There is one thing you should understand though, before you do invest. This company is not going to compete with Wal-Mart (WMT) and Target (TGT). They’re not going to try to. Same store sales growth at Sears Holdings will lag those of both arch rivals. I saw a quote in an AP story today saying something like it’s impossible to survive in retail without same-store sales growth that translates into maintained or increased market share.
If you believe this to be true, shares of SHLD are not for you. I can tell you right now that Sears Holdings is not going to gain market share. The company is going to be run just like AutoZone (AZO) has been in recent years. The focus is going to be on profits, not sales. AutoZone has been lagging its competitors in both sales store sales growth and market share for years. However, judging from the stock’s performance (it’s risen from $20 to nearly $100 in the last 5 years) you’d never know it.
Eddie Lampert’s ESL Investments owns a third of AZO stock, as well as half of SHLD. Lampert has been influential in AutoZone’s strategy of maximizing earnings per sahre, not sales, and he will do the same thing at Sears. Oftentimes this is accomplished by choosing to invest money in share buybacks, as opposed to store expansion. The way Lampert sees it, if buying back stock is more profitable than opening a new store, he’s going to buy back the stock. Retail analysts will focus on normal metrics of the retail business, but shareholders will see earnings per share rise,which will boost the price of SHLD shares.
If you hear analysts and retail experts knock the prospects of Sears Holdings due to the reasons I have mentioned, the appropriate reaction is to laugh, and buy the stock if it has fallen due to those negative comments. The day to sell SHLD will come when they can no longer increase earnings at a meaningful rate. I think that time is years away, which is why I continue to like and recommend the stock.
How is it possible that a large cap industry leader can grow its earnings more than 90% over half a decade and yet return a negative 15% to shareholders? Did Wal-Mart do anything wrong, and if so, what?
No, Wal-Mart management did nothing wrong from 2000 to 2005. In fact, they did exactly what their job was, to grow the business into the world’s most dominant retailer. The fault lies with the shareholders who bought the stock at $55 five years ago.
Now you might think that accusation is absolutely preposterous. After all, aren’t investors who saw the growth potential in Wal-Mart back then very perceptive? Didn’t they do exactly what a good growth investor should do?
I would argue against that notion. In fact, Wal-Mart investors made a very common mistake, a mistake that hundreds of people fall victim to every single day on Wall Street. They wanted to own shares of WMT but didn’t pay any attention to how much they were paying for them.
I’m not talking about share price. Many people conclude a $5 stock is “cheap” and a $100 stock is “expensive.” In fact, share price alone does not make a stock good or bad, cheap or expensive. Investors who bought WMT shares at $55 in May of 2000 forked over a whopping 40 times earnings for the stock ($55 per share divided by $1.39 in earnings).
Contrary to the common belief that stock prices follow earnings growth, there are many exceptions. When stock have enormous P/E ratios (a P/E of 40 is about 3 times the average stock’s P/E since 1900) it is often a signal that investors are getting a bad deal, regardless of the company’s future growth potential. If the P/E multiple that investors are willing to pay decreases dramatically over time, not even a 91% gain in profits can make up for the damage shareholders will incur.
Today Wal-Mart stock trades at $47, or 18 times this year’s expected earnings. If you have a company’s P/E ratio fall from 40 to 18, and earnings grow 91%, you are left with a 15% loss on your investment. This can explain why the high-flying tech stocks on the late 1990’s are down so much from their peaks. Cisco Systems (CSCO) is making more money now than they ever did during the Nasdaq bubble, but instead of trading at $82, which was its all-time high in early 2000, the stock is under $20 a share today.
This example should help investors realize that oftentimes the key to growth stock investing is the price you pay, and not the future growth of the company you are investing in. Even though the hype for many promising growth companies can be hard to ignore, try not to lose sight of that.
Let me give you a couple of statistics and then I’ll ask a question. Wal-Mart (WMT) has grown its annual sales from $180 billion in 2000 to an estimated $317 billion this year, a total increase of 75%. Earnings per share since 2000 have soared from $1.39 to an estimated $2.66 for 2005, an increase of 91%.
Investors are constantly searching for growth when they try and pick winning stocks. People who foresaw the growth that Wal-Mart could sustain so far this decade clearly have done well, right? There is little doubt that having achieved revenue growth of 75% and profit growth of 91% over a 5 year period would be reflected in a very strong gain for Wal-Mart stock. This leads me to my question. How have shares of Wal-Mart performed during that 5 year span?
If you ask former Fidelity star mutual fund manager Peter Lynch this question, he would most likely tell you that over time stock prices follow corporate earnings. As a result, estimating WMT shares have risen 91% in the last 5 years would be a good answer, because for the most part, Lynch’s statement proves correct.
The only problem is, there are exceptions to that rule. Just because a company grows at a very rapid pace, this does not ensure significant price appreciation of that company’s stock. In fact, despite sales growth of 75% and earnings growth of 91% since 2000, Wal-Mart shares have lost 15 percent of their value during that time, falling from $55 to $47 per share.
Part 2 of “The Wal-Mart Bear Market” will be published shortly, and will examine why WMT investors have suffered and what we can learn from this example.