Sears Holdings is Back at $31, Where's the Value? Price/Book at 0.44 (SHLD)

Former Kmart HQ (Troy, MI) sold to BlackRock in 2005
To close off 2011 with a bang, Sears Holdings Corp. (SHLD), which owns Kmart and Sears, and majority owned by hedge fund manager and Sears Holdings chairman Edward Lampert (ESL Investments/RBS Partners), announced on 12/27/2011 that holiday sales were weak so they plan to close 100-120 marginally performing stores and record a non-cash charge of $1.6-$2.4 billion. They released a list of 79 stores closing and I found an interactive map as well.

I was watching SHLD's price action on 12/21/2011 and it looked terrible on the chart (made a new low, can ESL buy Sears CDS?). When the big news hit on 12/27, SHLD closed at $31.78 on Friday, down 27%. It is retesting the 2008/2009 lows and back at 2003/2004 levels, when Kmart (KMRT) emerged from bankruptcy in 2003. Kmart acquired Sears (S) in November 2004 for $11 billion (or eventually $12.3 billion in 2005) to form Sears Holdings Corp (SHLD). Out of bankruptcy, Kmart was a nice real estate play for Lampert since Kmart owned real estate recorded at low historic book values, and real estate was about to go parabolic.

BusinessWeek: The Next Warren Buffett? 11/22/2004:

"And he pushed for Kmart to sell 68 stores to Home Depot Inc. (HD ) and Sears to raise a total of $846.9 million. That's nearly as much as the $879 million value placed on all of Kmart's real estate -- 1,513 stores, 16 distribution centers, and the fixtures -- in bankruptcy proceedings."

While I'm at it, check out the chart of SHLD's price/book ratio going back to 2003 courtesy of ycharts. It is at 0.44 as of 12/30/2011. Since October 2004, SHLD's price/book ratio has been in a range between 0.38 (11/2008) and 2.31 (10/2006). What is 0.44 trying to say here? Is there still hidden real estate value or major equity erosion ahead.

Sears Holdings Corporation Price / Book Value Chart

After Sears was acquired, the combined company went from being a cash, tax credit, retail synergy, real estate backstop play to which magical retail company will Lampert acquire in May 2007. SHLD peaked out in April 2007, and the company decided to buy back shares.

NYT (12/30/2011):

"From February 2005 through October of this year, Sears Holdings spent $6.1 billion on share repurchases, nearly double the $3.2 billion it spent on capital expenditures. Over the same period, depreciation expenses — a reflection of the old capital spending that Mr. Lampert deemed excessive — came to $6.6 billion."

From 2003-2007, Sears Holdings made decent real estate and balance sheet moves which fueled profit growth during its bull run from $30 per share in 2003 to $195 in 2007. This of course was partly fueled by the real estate and CDO fraud bubble courtesy of cheap money. But real estate aside, if you search old articles, retail expert Howard Davidowitz wasn't a believer in Lampert's retail strategy from the beginning. And when sales and market share started slipping away to competitors, Davidowitz believed the success of SHLD was riding on Lampert's hedge fund abilities (putting cash to work). Value investors were starting to bail at this point. Third Avenue's Martin Whitman, who was also involved in Kmart's debt-to-equity conversion out of bankruptcy, sold 2.25 million shares in 2005. In 2006 the Third Avenue Real Estate fund dumped 250,000 shares. Whitman wasn't convinced of the retail story. I found another interesting article from 9/2005: "Lampert May Need 'Merchant's Eye' To Pick Fashions At Sears".

It doesn't end there folks. From Retail Traffic (1/2008):

"Howard Davidowitz, chairman of Davidowitz & Associates Inc., a New York City-based retail consulting and investment banking firm, thinks the company is on the verge of closing hundreds of Sears and Kmart locations as a possible precursor to a liquidation.

But Davidowitz also doesn't think the liquidation will be all that smooth, saying it could take up to 15 years to unwind the various real estate holdings and lay off the tens of thousands of employees.

"In eight years Sears will be half the size if it exists and Kmart will not have survived," Davidowitz says.

Davidowitz continues to warn about the online retail revolution and its effect on retail commercial real estate. Bronte Capital has an interesting post up about the Sears Holdings news: Sears Holdings liquidation sale. Here's a portion of the Sears Holdings release.

Sears Holdings Provides Update, 12/27/2011:

"Kmart's quarter-to-date comparable store sales decline reflects decreases in the consumer electronics and apparel categories and lower layaway sales. Sears Domestic's quarter-to-date sales decline was primarily driven by the consumer electronics and home appliance categories, with more than half of the decline in Sears Domestic occurring in consumer electronics. Sears apparel sales were flat and Lands' End in Sears stores was up mid-single digits.

The combination of lower sales and continued margin pressure coupled with expense increases has led to a decline in our Adjusted EBITDA. Accordingly, we expect that our fourth quarter consolidated Adjusted EBITDA will be less than half of last year's amount. For reference, last year we generated $933 million of Adjusted EBITDA in the fourth quarter ($795 million domestically and $138 million in Canada).

Due to our performance in 2011 we expect that we will record in the fourth quarter a non-cash charge related to a valuation allowance on certain deferred tax assets of $1.6 to $1.8 billion. Although a valuation adjustment is recognized on these deferred tax assets, no economic loss has occurred as the underlying net operating loss carryforwards and other tax benefits remain available to reduce future taxes to the extent income is generated. Further, we may recognize in the fourth quarter an impairment charge on some goodwill balances for as much as $0.6 billion. These charges would be non-cash and combined are estimated to be between $1.6 and $2.4 billion.

"Given our performance and the difficult economic environment, especially for big-ticket items, we intend to implement a series of actions to reduce on-going expenses, adjust our asset base, and accelerate the transformation of our business model. These actions will better enable us to focus our investments on serving our customers and members through integrated retail - at the store, online and in the home," said Chief Executive Officer Lou D'Ambrosio. Specific actions which we plan to take include:

  • Close 100 to 120 Kmart and Sears Full-line stores. We expect these store closures to generate $140 to $170 million of cash as the net inventory in these stores is sold and we expect to generate additional cash proceeds from the sale or sublease of the related real estate. Further, we intend to optimize the space allocation based on category performance in certain stores. Final determination of the stores to be closed has not yet been made. The list of stores closing will be posted at when final determination is made.
  • Excluding the effect of store closures, we currently expect to reduce 2012 peak domestic inventory by $300 million from the 2011 level of $10.2 billion at the end of the third quarter as a result of cost decreases in apparel, tighter buys and a lower inventory position at the beginning of the fiscal year.
  • Focus on improving gross profit dollars through better inventory management and more targeted pricing and promotion.
  • Reduce our fixed costs by $100 to $200 million.

Credit rating agencies were not happy about this. S&P may downgrade Sears' 'B' corporate rating and Fitch downgraded Sears Holdings to 'CCC' from 'B':

"NEW YORK, December 29 (Fitch) Fitch Ratings has downgraded its long-term Issuer Default Ratings (IDR) on Sears Holdings Corporation (Holdings) and its various subsidiary entities to 'CCC' from 'B'. The ratings on various tranches of debt have also been downgraded by a notch. The Rating Outlook is Negative. A full rating list is shown below.

The downgrades reflect the continued deterioration in EBITDA on worse than expected top-line growth, with both Kmart and Sears running negative mid-single-digit comps in the fourth quarter. EBITDA for 2011 is expected to be below $400 million versus $1.5 billion in 2010, based on Sears' update provided through Dec. 25, 2011. As a result, credit metrics continue to be pressured and leverage is expected to be 8.0 times (x) or more in 2011, up from 4.6x in 2010, versus Fitch's prior expectation of leverage increasing to the 6.0x-7.0x range. In addition, there is increasing risk that EBITDA could turn negative in 2012 with top-line contraction in the mid-single-digit range (due to comparable store sales decline and store closings) even if gross margin remains flat with 2011 levels. As a result, Sears will need to fund operations with increased borrowings.

Liquidity is expected to remain adequate to fund 2012 working capital needs given current availability under the company's U.S. and Canadian facilities. However, Sears may need to access external sources of financing to fund operations in 2013 and beyond, as the magnitude of the decline in profitability and lack of visibility to turn operations around remain a major concern. If Sears is unable to access the capital markets or find other adequate sources of availability, and EBITDA remains at the current rate or lower, there is a heightened risk of restructuring over the next 24 months."

Below are weekly and monthly charts of Sears Holdings (SHLD) and a comparison chart of SHLD, Target (TGT), JC Penney (JCP), Target (TGT) and the Retail ETF (XRT).


Sears is still in secular bear market. It needs to find a base and gather strength to break through those downtrend lines. Look how its competitors are destroying it. This is just another retail disaster (see Borders and Blockbuster). Any college graduate, or even dropout, could have told these hedge fund managers for free that these weren't the best investments!