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Sears Holdings Corp (SHLD): Undervalued In Run-Off?


BargainValueHunter
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http://www.istockanalyst.com/article/viewarticle/articleid/4909893#

 

SHLD owns 808 of its locations, sixteen of which are part of Sears Canada. Looking strictly at its American owned properties, including its offices in Hoffman Estates and Troy, as well as the sixteen distribution centres it owns, we can make conservative estimates of the rate per square foot that would be obtainable if the locations were sold. SHLD provides average square footage for its different real estate categories.

 

My estimated square footage and rents per square foot (using triple-net leases):

 

    * Retail Space: 91.25 million sq ft. @ $6/sq ft = $547.5 million

    * Office Space: 2.09 million sq ft @ $9/sq ft = $18.81 million

    * Distribution Facilities: 11.2 million sq ft @ $4/sq ft = $44.8 million

 

Using a capitalization rate of 7% (I believe this is a conservative estimate – a case could be made for closer to 6%), we would get a rough value of this real estate of $8.73 billion (this number could easily be as high as $12 billion depending on the assumptions being made).

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Yep, that's pretty much the standard long opinion -- which I share. 

 

One issue with the real estate, which became clearer and more important over the past two years is the timing of the monetization of those assets.  Real estate that is hypothetically worth several billion might take many years to actually turn into cash.  So, the value is tied to how quickly you can make those transactions.  In 2007 that real estate was valued at one price given prevailing rates and an expectation that the assets could be flipped quickly, giving Eddie a pile of cash to invest.  These days, the real estate still has value, but it's harder to see how those assets get turned into cash in a timely manner.  I think patient investors will be rewarded, particularly given the ongoing cash flow and share buybacks.  But, it will take time.

 

As Berkowitz has said, if they do figure out the retail piece, that's gravy. 

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I am not anti-Sears, but I don't think SHLD will get the benefit of Eddie's capital allocation skills.  It is not an investment vehicle.  ESL is.

 

I think the cash from retails ops will fund buybacks and pay down debt, but little else.  Perhaps this will change 5 - 10 years from now, but the story is what it is.

 

SHLD is interesting b/c people hate the stock but it does generate cash.  Personally, I think it is fairly valued up in here and wouldn't be buying. 

 

 

 

 

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I am not anti-Sears, but I don't think SHLD will get the benefit of Eddie's capital allocation skills.  It is not an investment vehicle.  ESL is.

 

I think the cash from retails ops will fund buybacks and pay down debt, but little else.  Perhaps this will change 5 - 10 years from now, but the story is what it is.

 

SHLD is interesting b/c people hate the stock but it does generate cash.  Personally, I think it is fairly valued up in here and wouldn't be buying. 

 

I agree about the current price.  Around $90 it isn't obviously cheap, or obviously expensive.  In the low 60's a few months ago it was obviously cheap.  I think the sum of parts run-off valuation and the ongoing buy backs put a reasonable floor under the price somewhere in the low 60's.

 

I also agree about the short term use of cash flow.  Obviously, Eddie is retiring shares and doing a little restructuring with the debt.  Mostly, he's securing his hold and putting cash to use where it makes sense to him. 

 

Watching SHLD these days is like watching a python eat a pig.  The pig is only half way in the snake's mouth, but there's no doubt how the process will end up.  A good entry price and patience will be rewarded. 

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Valuegeek - I think we both said that SHLD is not an investment vehicle, but you managed to do it in a way that disagreed with me. 

 

Kudos on arguing for the sake of arguing.

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One of my problems with Sears is that even if Lampert doesn't allocated internal capital to the poor returning Sears/Kmart domestic stores (and tries to funnel it to the better operations), he is essentially doing so in large amounts through share buybacks.

 

Bruce Berkowitz summed it up perfectly while trying to pitch the long case on CNBC recently: "...when I look at the revenues of the company, given the number of shares that have been bought back, if you look at revenues per share it has not been going down, it has been flat."

 

I am usually a big fan of buybacks but not when the overall value of the business is declining. The buybacks have maintained revenue and profit on a per share basis. So really, the buybacks are a stealth form of capital investment, just like when a retailer plows money into new stores to maintain sales. Except, in this case it could be argued it's even worse because the money is going back into depreciated, dilapidated assets.

 

How much the actual company's value is declining or if it's declining at all is a matter of debate. As you can see I lean toward the "declining" side.

 

Had Buffett, in the early '70s, plowed the textile mill's excess cash flow into buybacks even when Berkshire's stock was cheap the company would be a fraction of the size it is now. For Henry Singleton at Teledyne it worked perfectly in the '70s because he had bought a lot of great, growing businesses in the '60s with inflated stock. It was like he was reinvesting "capital" back into the businesses at a high ROIC even if they didn't need any physical assets.

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Sear's equity is priced at almost $10 billion.  Plus it has about $3 billion of net debt.  The total price to own the company free and clear is about $13 billion.

 

If all of the real estate is worth about $8.7 billion (per the linked article) and the value of the company comes from selling all the real estate, then why is there "hidden value" when the enterprise price exceeds the asset value?

 

If the answer is that the company can sell the properties and lease them back to continue to operate the stores, then I'd argue that you are left with the most unattractive component of the business (a dying retailer), whose operating income would be severely dimished (if not completely evaporated) by the new, incremental costs to lease all of it's formerly-owned properties.

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tooskinnee - its me, toof'ingfat.

 

I tend to agree with your assessment.  SHLD is a FCF play IMO, not the real estate play we read in businessweek 5 years ago.

 

Maybe a Canada play (hate to admit that on this site) and a .com play, as these are drivers of earnings and FCF, but not a real estate play.

 

 

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The buybacks have been mentioned several times throughout this thread...

 

I can't give him any credit for being a master capital allocator related to his buying back shares.  No more so than a company that pays dividends is a master capital allocator.  The buybacks are merely the return of cash flow.  Stop thinking of the buybacks as any special recipe of value creation here.

 

The only thing that matters is the price to cash flow.  This other matter is a distraction.  The only thing "masterful" about the buybacks is that he is returning the cash flow to you in recognition that he has NO MEANINGFUL USE FOR IT -- if that isn't an endorsement of SHLD as not being an investment vehicle, then I don't know what is.  At least he is returning the cash flow instead of devaluing it via bad investments... that I'll give him credit for.

 

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"I can't give him any credit for being a master capital allocator related to his buying back shares.  No more so than a company that pays dividends is a master capital allocator.  The buybacks are merely the return of cash flow.  Stop thinking of the buybacks as any special recipe of value creation here."

 

So all buybacks or dividends create an equal return on capital (or return of capital) for shareholders?

 

Correct.  Return to shareholders -- nothing more or less.

 

 

 There's no way to grow per share business value by thoughtfully buying back one's own shares at discounted prices?  

 

No more so than to just buy more shares with the dividend.  Is two quarters worth less than a 50 cent piece?  It's more tax efficient in the buyback route -- but taxation is the only source of added value.

 

 

Or no way to destroy per share value by overpaying for such shares?

 

 

Correct.  

 

To quote Malboussin:  "You are making an active decision if you do not sell any shares while a company is buying back stock. Doing nothing is doing something— increasing your proportionate stake in the company by effectively reinvesting."

 

Given the scale of the parent company buyback (not to mention the increase in the Sears Canada stake), it seems hard to argue that he has "NO MEANINGFUL USE FOR [HIS CASH FLOW]".  Eddie is allowed by the board to invest the cash as he sees fit - in the underlying businesses, in private businesses, in related publicly-traded businesses - and he's decided to buy back 40% of the shares that he doesn't own (not counting Fairholme) in the business that he knows better than anyone else in the world.  He may be wrong, but that's definitely an investment.  Whether that makes Sears an investment vehicle or just a "portfolio of businesses" (to quote from the Chairman's letter) is merely semantics.  

 

 

The key fact is that he is "building value" for you via buybacks no faster than if you are getting more shares through a DRIP.  So why does he do it?  Probably he wants ESL to buy more shares, but he doesn't want to pay tax on a dividend in order to boost their stake.

 

Whatever his motives for the buyback, my point is that it's just a tax-efficient dividend of your free cash flow.  You can choose to hold your increased stake or sell -- no different from getting a dividend and choosing to buy more or not buy more.

 

 

Sorry, but I like that so much I am going to repeat the question:  Is two quarters worth less than a 50 cent piece? 

 

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A few questions:

 

"Sears closed a combined 34 Kmart and Sears stores in 2010 and added 122 specialty stores."

 

what specialty stores, does anyone know?

 

With regards to buybacks and the new CEO:

 

"D'Ambrosio's resume includes serving most recently as CEO at Avaya Inc., a telephone and software technology company, where he was instrumental in taking the company private in a $8.2 billion deal with two private equity firms in 2007."

 

"He noted D'Ambrosio's technology background would be a strength as Sears builds a business that's more focused online. He also highlighted that Avaya's going private helped deliver "attractive returns to its shareholders," raising speculation that Lampert may be thinking about such a move for Sears."

 

buying back to take it private?

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"I can't give him any credit for being a master capital allocator related to his buying back shares.  No more so than a company that pays dividends is a master capital allocator.  The buybacks are merely the return of cash flow.  Stop thinking of the buybacks as any special recipe of value creation here."

 

So all buybacks or dividends create an equal return on capital (or return of capital) for shareholders?

 

Correct.  Return to shareholders -- nothing more or less.

 

 

 There's no way to grow per share business value by thoughtfully buying back one's own shares at discounted prices?  

 

No more so than to just buy more shares with the dividend.  Is two quarters worth less than a 50 cent piece?  It's more tax efficient in the buyback route -- but taxation is the only source of added value.

 

 

Or no way to destroy per share value by overpaying for such shares?

 

 

Correct.  

 

To quote Malboussin:  "You are making an active decision if you do not sell any shares while a company is buying back stock. Doing nothing is doing something— increasing your proportionate stake in the company by effectively reinvesting."

 

Given the scale of the parent company buyback (not to mention the increase in the Sears Canada stake), it seems hard to argue that he has "NO MEANINGFUL USE FOR [HIS CASH FLOW]".  Eddie is allowed by the board to invest the cash as he sees fit - in the underlying businesses, in private businesses, in related publicly-traded businesses - and he's decided to buy back 40% of the shares that he doesn't own (not counting Fairholme) in the business that he knows better than anyone else in the world.  He may be wrong, but that's definitely an investment.  Whether that makes Sears an investment vehicle or just a "portfolio of businesses" (to quote from the Chairman's letter) is merely semantics.  

 

 

The key fact is that he is "building value" for you via buybacks no faster than if you are getting more shares through a DRIP.  So why does he do it?  Probably he wants ESL to buy more shares, but he doesn't want to pay tax on a dividend in order to boost their stake.

 

Whatever his motives for the buyback, my point is that it's just a tax-efficient dividend of your free cash flow.  You can choose to hold your increased stake or sell -- no different from getting a dividend and choosing to buy more or not buy more.

 

 

Sorry, but I like that so much I am going to repeat the question:  Is two quarters worth less than a 50 cent piece?  

 

 

 

 

Forgive me if we're saying the same thing in different words but there are two questions as I see it.  One concerns whether a reinvested dividend is theoretically and practically equivalent to a stock buyback.  The second is whether stock buybacks can grow per share business value.  

 

Yes, well I don't disagree that per share business value goes up.  But that's overrated -- I mean, compared to just having more shares.  I don't see as I put it any advantage to your having 1 quarter that grows to 50 cents in value (via buyback), or instead just acquiring a second quarter (via dividend).  When I comment that no special value is created, I'm referring to the alternative action which is to just return the cash as cash.  Value investors are a funny lot -- you don't see them bragging about master capital allocators that pay dividends.  Like "Oh my god man, that person is a genius because he paid a dividend so now I have purchased an additional share and therefore I now own more cash flow!".  Either way you own more of the business cash flow...  it's just a matter of tax, and somewhat a little bit trading costs.

 

Value investors don't cut through the crap and just say "wow, Eddie saves us tax and trading costs"... no, they speak of the buybacks as if there is some value conjuring force at work.  As if there is something special to SHLD other than the businesses it holds.

 

And yes, it's true that SHLD is a portfolio of operating companies.  So is Proctor & Gamble -- but we don't speak of PG as an investment vehicle.

 

I don't know whether a study has been done, but I intuit that over the long haul you'll come off ahead (if you have sufficiently large positions) if they always just buy back shares and you sell an offsetting portion after getting the news on the amount and price.  Right now the dividend tax rate is low, but when they restore it to prior levels it provides a large margin of safety between the price paid in the buyback and the price you sell it at a few months later.  Over time it will wash out (sometimes you sell higher than they bought) and the tax benefit will largely put you ahead I suspect.

 

 

Fundamentally, its hard to imagine why you would want to be invested in a business where you were uncomfortable with management's capital allocation - whether they're increasing their and your underlying stake in the business through buybacks or whether they're returning a similar amount of capital through dividends (I can't recall seeing a management dividend reinvestment program for their own stock?).  Despite attempts by academics like Modigliani and Miller, this isn't rocket science - it's just simple business.  

 

Why in the hell would we ever own shares that were overvalued?  So why ever worry about "paying too much" in a buyback?  Sounds like an argument for academics, but not value oriented people like us who don't own overvalued stock right?  Isn't that just simple investing sense?

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Sorry, but I like that so much I am going to repeat the question:  Is two quarters worth less than a 50 cent piece? 

 

Isn't this only true if: 1) you can use the dividends to buy stock at the same price that the company potentially could, and 2) buyback amounts are smoothed out like dividends are?

 

1) Management can opportunistically time buybacks when stock is cheap (which could be at anytime throughout the year) but the dividend receiver has no such luxury (unless he borrows to buy in anticipation of paying back when dividends are paid). Management also has the not so small advantage of being the ultimate insider which should place it at some advantage in its buyback activity.

 

2) Dividends tend to be smoothed out so in periods like 2008-9 when stocks became ridiculously cheap, a buyback strategy may give management a much freer hand to substantially increase its "payout" without having to worry about maintaining that payout in the future.

 

So, assuming, management is rational and sensible, I would much rather they do the buybacks than me (through dividends). In addition to the tax advantage, the benefit over the long run could be significant.

 

Conclusion: Two quarters are not always equal to 50 cents - e.g. when the quarters are Canadian and the 50 cents HK.

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Sorry, but I like that so much I am going to repeat the question:  Is two quarters worth less than a 50 cent piece?  

 

1) Management can opportunistically time buybacks when stock is cheap (which could be at anytime throughout the year) but the dividend receiver has no such luxury

 

 

What if the market crash happens during a blackout period and the company buyback plan misses the boat entirely or at least substantially?

 

The management can pay the cash out faster than it can buy shares in the market.  Shareholder can sit on the cash and wait for the right time.  Management is restricted to purchasing something like 25% of the daily volume average -- the individual shareholder is not best served by such restrictions.

 

2) Dividends tend to be smoothed out so in periods like 2008-9 when stocks became ridiculously cheap, a buyback strategy may give management a much freer hand to substantially increase its "payout" without having to worry about maintaining that payout in the future.

 

I don't agree with management that feel they have to maintain a dividend when they can't afford one.  They seem to desire a consistent payout, and this keeps them from bumping it up and down.  They get too many questions otherwise and likely do it to make their professional lives more convenient.  Microsoft however once managed a "special" dividend as did Leucadia -- don't see why such dividends are not more common, especially during market crashes when prices are cheap and there is too much cash to deploy in buybacks (I'm referring to that slow 25% accumulation rate).  Eddie could have done a special dividend in late 2008 and early 2009 for example and shareholders could have grabbed more shares in a shorter period of time while the getting was still incredibly good.  I'll bet the corporate pace of buybacks lags such an approach, but of course this is just my intuition again -- a "thought experiment".

 

For an investment vehicle, I like the way Berkshire has been managed.  He'll buy other non-Berkshire businesses -- the advantage here is that he has a zillion lifeboats he can sell if he ever needs cash.  Somebody else trying to run an investment vehicle might take the attitude that his own stock being just as cheap as another stock, might buy more of his own stock.  That person undervalues the importance of the lifeboats.  If SHLD is an investment vehicle then I think he should be gobbling up more lifeboats.  But if SHLD is merely an operating company, then Eddie is doing the right thing by just returning cash.  Just another reason why I think he isn't running it as an investment vehicle.

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The article writer is a smart guy and worth following, but he seems to ignore tax effects on land sold, and he double counts the value of the U.S. land in his business value. A going concern on a piece of property is a competitor to the next best use, so a multiple on the business is also an implied valuation of the current use of land.

 

The article notes a current after-tax FCF to real estate yield of 8.3% which should be regarded as a competitor to the 7% cap rate before capital tax.

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Just read the SHLD annual letter. 

 

I like the way the guy thinks about capital allocation, but I can't stand when he starts preaching about job growth, the evils of regulation, and Friedrich Hayek and whatnot.

 

I was just thinking about that today!  Basically sounds like someone throwing popcorn from the bleachers if you will.  If he has an issue with these things he should become more involved politically.  Maybe he is, who knows?  The 'opinion' about Amazon not collecting taxes vs SHLD and others having to also sounded like an opinion piece. I mean if it's important to the business and I believe it is, there should be a call to action or a description of the actions that SHLD is or has taken no?  But I do agree that his political opinions are kind of weak and out of place in an annual letter.

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