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.

1 comment:

IveyTraders said...

This appeared in Barron's this weekend. I continue to like PIR as a value play.



WE ALL KNOW THE OLD JIBE advising someone to take a long walk off a short pier. Whatever humor there is in it would probably be lost on investors in Pier 1 (PIR), who have been soaked amid the retailer's skein of sales shortfalls and the headlong collapse in its shares.

The home-goods chain, quite simply, has blown it repeatedly by stocking the stores with stuff that seemed to lack customer appeal, at a time when the overall furnishings sector was in slowdown mode and cheap Asian-made furniture was glutting the market. Sales at stores open at least a year have been sagging for several quarters, and last year the company began to burn cash.

Pier 1 was written up positively by Barron's in an ill-timed and unfortunately headlined feature in late 2003 ("Back in Fashion," Nov. 3, 2003), with the stock around 23. It quickly ran up 12% in a month, and then began a long and steep decline that has taken it to its recent level of 9.20. A subsequent Barron's feature correctly reversed the earlier take, saying the shares, then above 15, had downside risk to 10 ("Cleaning House," April 25, 2005).

Without forgetting that other old saying about not trying to catch falling knives, the stock just might be in the process of getting washed-out enough for bottom fishers to cruise in.

Start with the fact that the company has made many enemies on the Street with its losing streak and is now roundly hated. Three out of 20 analysts recommend the stock, with four rating it a Sell. More than 14% of its shares were represented by short positions as of a month ago.

In truth, it's understandable that retail analysts are negative on Pier 1, because they rightly focus on sales trends and margins, and not much is reassuring on those fronts. The shares aren't demonstrably cheap based on expected earnings. After a steady plunge in estimates, the forward consensus forecast for the coming year's profits sits at 15 cents a share.

But at a certain price, the stock will begin to scrape against its asset value. Last week the company denied rumors that it had hired an investment bank to explore its options. But even the fact that such talk is circulating suggests a certain amount of strategic urgency is called for.
Holding Steady: The New Year's rally slowed last week. After the Dow cracked 11,000 for the first time since June 2001, profit-taking took hold and the index ended flat for the latest five trading sessions. Alcoa weighed on the Dow after issuing a weak profit report.

The rudimentary math goes like this. Pier 1 has an $800 million market capitalization, with a mere $28 million in debt at last report. Sales are pegged to reach $1.9 billion in the fiscal year ending next month, for a price-to-sales ratio under 0.5 to 1. The chain numbers more than 1,200 stores.

The number of stores and level of sales imply that the company has much to work with in restructuring or re-merchandising or cost-cutting its way to a turnaround. Its store base boasts good locations, perhaps allowing Pier 1 to pare its physical footprint strategically and profitably, if it chooses. And naming a new merchandising chief alone might turn investor opinion for the better.

The dividend yield is above 4%, and investors who have spoken with Pier 1 executives say the company is committed to maintaining the payout. The company's headquarters building is estimated to be worth about $100 million, 12% of the company's current market value.

The stock, meanwhile, has increasingly migrated into the hands of seasoned, patient value investors. Though the shareholder filings are stale, dating to the quarter ended Sept. 30, they show that large holders Royce & Associates, Fidelity (where it's been owned by the successful Fidelity Value and Low-Priced Stock funds) and Olstein & Associates all significantly increased their positions into the decline.

Berkshire Hathaway (BRKA) caused some excitement when it reported an eight million-share stake in Pier 1 in 2004, but that slug was cut back to below four million at last report. It's not clear whether Warren Buffett or another Berkshire official was behind the interest in Pier 1.

There are no sure bets in retail, especially when a company has lost its fashion touch, as the Gap and others have shown. But with Pier 1 purging old inventory and readying a new product mix, it should be clear relatively soon whether the company has regained customers' affections.

If not, then some kind of catalyzing transaction can't be ruled out, in a market where struggling also-ran retailers like Linens 'N Things (LIN) have drawn leveraged buyout offers.