Monday, November 07, 2005

Wonder what their spawn will look like.

The Sears Catalog of Problems
1282 words
6 November 2005
The New York Times
Late Edition - Final
Copyright 2005 The New York Times Company. All Rights Reserved.

IT'S just about time to celebrate the first anniversary of the Kmart and Sears marriage, brokered by Edward S. Lampert, the hedge fund manager, last Nov. 18. From the looks of this combination, Mr. Lampert should stick to investing, not matchmaking.

When he struck the $11 billion deal that turned the two struggling merchants into the nation's third-largest retailer, Mr. Lampert acknowledged that the challenges were formidable. But investors bid up shares of the combined company, Sears Holdings, to more than $163 last summer on a hunch that even if its operations were lackluster, its real estate holdings were as good as gold.

The stock is now down from those levels, yet the operational hurdles facing the company remain exceedingly high. Sears Holdings shares closed last week at $124, up 25 percent for the year but down 24 percent from their high reached in July.

Mr. Lampert has won praise for his investment skills and for the turnaround at Kmart, where he played a major role in its emergence from bankruptcy. But Sears Holdings, where he is chairman, may be a textbook example of why investors should not confuse a manager's financial acumen with operational expertise.

''I was extremely enthusiastic and supportive of the Kmart turnaround, which I thought was brilliant,'' said Richard Hastings, senior retail analyst at Bernard Sands in New York. ''But the Sears-Kmart combo represents a different set of questions and I don't see the answers as being adequate. The thing is severely underinvested; the stores don't look good enough. And it's one thing to hire talented people, but if you're going to be in retailing you have to be in it all the way up to your eyeballs and get in there, fix up those stores and spend the money.''

The dearth of spending at Sears is not only evident in its 3,500 stores in the United States. It also shows up on the company's financial statements. Capital expenditures at Sears Holdings for the first six months of this year were $180 million, or $360 million at an annualized rate. By comparison, expenditures by Wal-Mart last year were $12.9 billion; Target's were $3.1 billion.

While most retailers do not break down what they spend on new stores versus the amounts for sprucing up existing stores, rough figures can be determined. Analysts say that large retailers typically put two-thirds of their capital costs into new stores while one-third is spent freshening up older ones.

Applying these figures to Wal-Mart's and Target's capital expenditures provides a glimpse of what these companies spend to maintain their stores. These figures allow a comparison to the spending by Sears.

If Wal-Mart put 35 percent of its total capital expenditures into store maintenance last year, that would have amounted to roughly $4.5 billion, or just under $7 a square foot. Per store, Wal-Mart probably spent more than $850,000 last year in updates and redesigns.

Using the same assumptions, Target spent an estimated $1.1 billion on store maintenance. Given its 165 million square feet in stores across the country, that comes to $6.51 a square foot for redesign, new lighting and displays. On average, Target probably spent a bit more than $900,000 in each store.

Last year's figures are not available for Sears and Kmart, because their operations were combined this year. But doubling the figures for the first six months of this year shows that Sears is spending roughly $94,000 per store on maintenance, or $1.33 a square foot -- about a fifth of what Target and Wal-Mart spend.

ASKED about the company's capital expenditures, a Sears spokesman declined to comment. But the company's same-store sales, those for stores open at least a year, certainly point to less-than-enthusiastic shoppers.

For the 13 weeks ended July 30, Sears Holdings' total revenue declined 2.1 percent from the period a year earlier, the company said. By contrast, Target's revenue grew 13.6 percent in the most recent quarter, while Wal-Mart's net sales rose 10.2 percent.

Same-store sales fell 4.4 percent in the quarter at Sears Holdings, compared with gains of 6.7 percent at Target and 3.5 percent at Wal-Mart.

Clearly, Sears Holdings' operations are faltering. But there's always the real estate play, right?

The investor excitement over the potential in the company's retail properties was largely a result of two deals struck even before the merger. One was in August 2004, when Kmart sold 18 stores to Home Depot for $271 million. And the next month, Sears bought 50 Kmart stores for $576 million.

The Home Depot sale apparently netted Kmart more than $150 a square foot for some of the stores it sold. But more recent sales indicate that the $150-a-square-foot figure has been the exception, not the rule.

Feldman Mall Properties, for example, a real estate investment trust that buys underperforming shopping malls and refurbishes them, earlier this year paid $68.50 a square foot for a 1.2-million-square-foot mall in Albany. Sears and Macy's are the anchor tenants in that mall.

And May Department Stores' decision a few years back to dispose of more than 30 Lord & Taylor stores provides another data point. The 24 stores that have been sold by what is now Federated Department Stores have generated prices of around $65 a square foot.

The Sears spokesman said he could not help with questions related to the company's real estate. But let's give Sears the benefit of the doubt and assume that the company can sell 50 stores a year for $100 a square foot.

Taking such a best-case view, the net present value of Sears Holdings' real estate could be $3.95 billion, or about $24 for each Sears Holdings share. (Obviously, the net present value would be far less at prices of $65 a square foot.)

That leaves about $100 per share that investors are paying for Sears Holdings' continuing operations. Assuming that the company earns $6.20 a share this year, the mean estimate from analysts, investors are paying 16 times earnings for a retailer whose sales are falling. That's about the same multiple to earnings that investors are paying to own Wal-Mart, a growing retailer.

Wall Street is -- surprise! -- high on Sears. Of the five big firms that follow the stock, four rate it a buy. Analysts at these shops think that the shares will trade between $145 and $185 in coming months.

But recent action in Sears Holdings' stock indicates some serious selling. An especially savvy investor who has been shedding the shares is Martin J. Whitman, manager of the Third Avenue Value fund. In a July 31 letter to shareholders, Mr. Whitman said his fund had sold 2.25 million Sears shares. That amounts to 96 percent of his fund's Sears holdings. Officials at Third Avenue declined to say whether additional shares had been sold since then.

While noting that Sears Holdings ''seems to be an exceedingly well-managed company with very good prospects,'' Mr. Whitman added that the company's success was ''far from assured.'' With the stock price in the stratosphere, ''it seemed prudent to lighten up the fund's position in Sears,'' he said.

Word to the wise.


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