Thursday, November 17, 2005

Sears Holdings and Pier 1

Ok, so I am talking about the un-sexy world of retail. I am not sure if you guys know much about the Sears story. To make a long story short, Eddie Lampert, a well known hedge fund manager ended up as the largest Kmart shareholder when that company emerged from bankruptcy. Soon after he engineered a merger with Sears to create Sears Holdings (Nasdaq: SHLD). The stock has come off its highs as people are starting to get nervous that Lampert may be a good investor, but he does not have the operational expertise to turn Sears around. A recent New York times article tried to argue that even as a real estate play the stock is overvalued. However, the article's reasoning was quite flawed. Plus, insiders, including a director, have recently been buyers of the stock. Meanwhile, Lampert has been plouhing through the share buyback program and retiring stock to the tune of $500 million. Sears has a good, albeit, tired brand. It has a vast underlying real estate empire, a Canadian operation, as well as well-known brands such as Kenmore and Craftsman. As for the operational side of things, Lampert has been emphasizing margins as opposed to top line growth. This is an unusual approach for a retailer, but it's all about cash flow for Lampert. On top of all this, Sears' cash pile is growing by the day and stands at around $3 billion. Lampert has been given free reign to use this cash as he sees fit by the board of directors. There has been talk that Lampert will eventually turn Sears Holding into an investment vehicle a la Warren Buffett's Berkshire Hathaway. If anything, buying Sears is giving you a rare opportunity to invest alongside one the most successful investors of our time. His ESL Investments hedge fund has had annual returns in excess of 25% since the late 80's! He has many billions under managment and has been entrusted with capital from the rich and famous including Michael Dell. I would say the downside is somewhat limited, but the upside could be huge. You can nibble at these prices (around $119 today) and load the truck below $110. This is a long-term play and a bet on Lampert.
Now onto Pier 1 (NYSE: PIR). This stock has been hammered. The company is getting its ass handed to it by the likes of Wal-Mart and Target. I was excited that Warren Buffett had added 8 million shares to his portfolio in Q2 at around $18. However, during Q3 he unloaded 5 million of those shares. The stock is now trading at $12 and a price to sales ratio of 0.6. It has a 3.5% yield. They have recently mailed their first national catalog in the US. They are also trying new ads on TV. Their balance sheet looks clean, although continued struggle could put the dividend at risk. Meanwhile, management has been buying back shares. The CEO has been at the helm for 30 years. So he has been through these cycles before. He may have his hands full this time though. A few more quarters of this and he may be sacked. As with Sears, I think the downside is somewhat mitigated here. It has bounced off of $10 twice in recent months and might be stuck at these levels for a while. But if there is a whiff of a turnaround, this stock has lots of room to the upside. I believe the stock is undervalued.