Faulty Sears Holdings Analysis

Fachidiot (German): An excessively narrow-minded technical expert. A man with a hammer.

Sears Holdings (SHLD) has recently been the subject of much discussion among the media and investor community. Below are a few quotes from an article in the Chicago Sun-Times discussing the thoughts of Gary Balter, a retail analyst at Credit Suisse.

…Sears could be a $188 stock if Lampert would sell valuable assets such as Sears Canada, Lands’ End, distribution centers, Sears’ headquarters in Hoffman Estates, and brands such as Craftsman and Kenmore.

Yes. And Berkshire Hathaway could be a $250,000 stock if Buffett would sell everything they own except the Acme Brick Company and Buffalo News. The brands mentioned above are very valuable, but they are critical to the success of Sears Holdings as a retailer. That’s right, Sears Holdings is a retailer. It seems as though this revelation has disappointed some investors over the past few weeks.

Sales productivity is $135 a square foot “and shrinking” at Kmart. That compares with Wal-Mart’s $584 and Target’s $314…

The story neglects to mention the sales per square foot number for Sears stores or what these numbers are being measured against. Near my offices, there is a beat-down old Kmart. The building is in disrepair, it’s perpetually under-staffed, and the large parking lot in front is never full. But surprisingly, it still gets a fair amount of business. However, here’s the thing—the property it’s on is very valuable, and they pay very little for it. I know, because I’ve seen the lease agreement. This particular Kmart pays about $3 a square foot (I don’t recall the exact number).

Compare that to lease rates at other big-box retailers of $12-15 a square foot. Even including the cost of inventory, the opportunity cost for this Kmart is less than a third of any other retailer. In 2006, Kmart’s average EBITDAR (income before depreciation and rent) was about $9-10 per square foot. For a Wal-Mart or Home Depot, these rates would result in unsustainable losses. But because of the low real estate cost, this Kmart can produce a good amount of cash, especially when considering the lack of any capital expenditures.

On the other side of town from me, there’s a Sears Grand. Next to it is a Wal-Mart Supercenter and Sam’s Club, and across the street is a Lowe’s. All four parking lots are usually packed. I sometimes wonder how there’s that many people living in this city. The point is, the Sears is popular, and SHLD continues to invest in it and other similar stores. Lampert doesn’t skimp out on spending when a dollar spent produces more than a dollar in value. Free cash flow from the beat-down Kmart (a lost cause in terms of revival) gets reinvested in higher return assets like Sears Grand and Lands’ End.

Lampert and the other Sears executives aren’t stupid. They know what’s worth it and what isn’t. Here’s a quote from an article in Fortune almost two years ago: “…Lampert is the company’s No. 1 user of a computer-based tool to analyze sales, margins, and inventories by store, region, and by merchandise group. A geek at heart, he spends hours at his Connecticut office drilling down into the data, zeroing in on whatever isn’t making money.”

Balter believes the answer is for Sears to get rid of its most valuable assets and realize that there’s no more profit to be squeezed from cutting costs at Kmart and Sears stores.

“Retailing is a very humbling profession, as Eddie is discovering,” Balter wrote. … “One better instill a sense of customer service in the associates to be successful.”

Once again, selling Sears’ crown jewels is exactly what not to do. And I doubt executives are just sitting around thinking of what costs they can cut next to “squeeze” out more profits (see my Kmart discussion above). Yes, they know customer service is essential in retailing—this isn’t rocket science. Gary Balter may be an expert in the retail industry, but it doesn’t seem to me that he quite understands Eddie Lampert’s long-term strategy or goals.

Disclosure: I own a position in SHLD. This is not a recommendation to buy or sell any security.

One thought on “Faulty Sears Holdings Analysis

  1. http://money.cnn.com/2007/12/04/news/companies/sears.fortune/index.htm

    Another article with much the same problems as Balter’s analysis above.

    “But by starving existing stores of capital, Sears is no better than a homeowner who forgoes that new roof. It can only rain for so long before the roof starts to leak.”

    Completely true, at least for the “beat-down Kmarts” I mentioned in the post. But only when the roof starts to leak on these SPECIFIC stores will Sears close them down, re-lease, liquidate, and allocate capital elsewhere.


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