In 2010, Sears Holdings (SHLD) soared over 250% from its low point a little over a year ago on speculation that a turnaround story was going to help the aging department store bounce back along the economy. Since then the stock has remained volatile but steadily falling. Today, with another quarterly loss and shrinking revenues, the turnaround story seems dead, and the stock is trading near the lows it hit in 2008.Before investing in Sears, there are two key questions that must be answered. First, what is the company’s book value and, secondly, how are its revenue and margins trending. The current book value is a bit below 10 per share by most accounts, and that figure tells us that the stock is still selling at over 3x price/book, which suggests that the market is pricing in a recovery and a move towards positive cash flow.
That brings us to our second question, on earnings and revenue. A historical look at the company’s past few quarters indicates that the real focus needs to be revenue growth.
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YY Growth
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2013 Q3
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2013 Q4
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2014 Q1
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2014 Q2
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2014 Q3
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2014 Q4
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2015 Q1
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2015 Q2
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Revenue
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-7%
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-2%
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-9%
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-6%
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-7%
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-14%
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-7%
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-10%
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EPS
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23%
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107%
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-303%
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-70%
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-153%
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-401%
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-194%
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-97%
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We see that EPS is erratic and negative; simply put, SHLD as it is currently operating is not a profit-making enterprise. Publicly, SHLD’s management has said that it is working on consolidating and improving operations, which involves some investment. That investment is aimed at improving sales. In other words, revenues matter here more than anything else.
Looking at that metric, it’s easy to be disappointed. Revenues have not grown in two years, which means comps are getting easier and easier, yet Sears is failing to show any improvement. In fact, revenue declines are clearly accelerating even as comps get easier; when compared against competitors Walmart (WMT), JC Penney (JCP), and Kohl’s (KSS), the company’s lack of growth is startling.
That does not mean it is an obvious short. One key issue is that the book value is controversial. According to the company’s most recent 10-Q, shareholders’ equity is $5.8b, but the market cap for the company is now $3.57b; if the company’s financial statements are to be trusted, that means the market is pricing it at a 62% discount. Furthermore, the company’s debt to equity ratio is impressive; just 18.5%, meaning the company has plenty of room to borrow to invest further.
According to the company’s most recent earnings release, Sears is not giving up. CEO Edward Lampert said in the statement, “Our second quarter earnings are unacceptable and we are taking steps to address our performance on several levels. This includes reducing costs as we evolve our business model, investing in our Shop Your Way and Integrated Retail customer initiatives, rationalizing our physical footprint and improving pricing and promotions. As we move through the transformation, our new programs are becoming more prominent both in how we run the company and in how we serve our members, and we are pleased with how our members are responding.”
An investment in SHLD ultimately must focus on this question: can Lampert succeed in this turnaround? Bears say he’s had enough time and is failing harder than he used to; bulls will say that there is plenty of credit, goodwill, and brand recognition to make the retailer shine again. After all, comparable store sales did not contract and if you discount consumer electronics, the retailer’s weakest section, comp stores saw sales growth of 1.6%. Online sales also grew 18%.
Investing in Sears depends on a belief that Lampert can succeed in this turnaround; shorting the stock depends on a belief that these initiatives will fail. The only way to make a certain bet is to do some due diligence in the retail market and understand exactly how valuable the Sears name and the company’s real estate holdings are in today’s market.