SHLDQ - Sears Holdings Corp

[peridotcapital]

Peridot I don't think Sears books sublease money from wholly owned subsidiaries (like Lands End) on that sublease line.

If not, do you know where they would include it?

[BTShine]

Your responses are appreciated.  If not all at once, I think SHLD will step up store closures as another way to attain profitability.

 

The major closings a few years back seemed to help profitability.  Another round should do the same.

 

 

[krazeenyc]

Peridot I don't think Sears books sublease money from wholly owned subsidiaries (like Lands End) on that sublease line.

If not, do you know where they would include it?

 

they have that table with the intracompany transactions -- I assume it is buried in there.  I assume the money that Sears Roebuck and Kmart pays KCD is not part of SG&A right? I further assume the money that KCD receives from Sears Roebuck and Kmart do not go to revenues either.  I am NOT an expert in accounting by any means.

 

[merkhet]

A little spitballing from the data in the LE filings.

 

From Page 61

 

As of August 2, 2013, our retail properties consisted of 275 Lands’ End Shops at Sears, which averaged approximately 7,400 square feet, and 16 Lands’ End Inlet stores, which averaged approximately 8,000 square feet.

 

From Page F-18, the 2013 lease commitments total $31.103 million.

 

A few quick calculations show that LE has about 2.163 million square feet of land, so if we assume it's all leased from Sears (and I know it's not but a bigger denominator lowers the calculation), then Land's End is leasing space from Sears at around $14.40 per sq. ft.

 

Let's further assume that LE is only showing up in the core properties, which I believe someone else here indicated was 400 properties totaling 68 million square feet.  Then perhaps those 68 million square feet alone should be worth a rental income of $977.81 million...

 

Thoughts?

[peridotcapital]

A little spitballing from the data in the LE filings.

 

From Page 61

 

As of August 2, 2013, our retail properties consisted of 275 Lands’ End Shops at Sears, which averaged approximately 7,400 square feet, and 16 Lands’ End Inlet stores, which averaged approximately 8,000 square feet.

 

From Page F-18, the 2013 lease commitments total $31.103 million.

 

A few quick calculations show that LE has about 2.163 million square feet of land, so if we assume it's all leased from Sears (and I know it's not but a bigger denominator lowers the calculation), then Land's End is leasing space from Sears at around $14.40 per sq. ft.

 

Let's further assume that LE is only showing up in the core properties, which I believe someone else here indicated was 400 properties totaling 68 million square feet.  Then perhaps those 68 million square feet alone should be worth a rental income of $977.81 million...

 

Thoughts?

 

Yeah, I think you're right on target. It also just happens to be the same rent number that Whole Foods pays across its entire store base, and they clearly have interest in the good Sears locations. So that ~$1.0B of rental income could be worth north of $10 billion, but the timing is the key. It could easily take 20 years to rent out 68 million square feet, so if that is the business model you assume Sears will pursue long term (they own a total of ~88 million sf), the present value is just a fraction of that today... maybe $2.0B or so...

[bmichaud]

I assume SPG, GGP, JCP and SHLD, combined, is a decent proxy for quality retail SF. Here is some data, in millions. 

 

SPG: 242

GGP: 126

JCP: 54 (quick look at a SA article that said JCP owned 49% of its 111.2MM SF)

SHLD: 68

Total: 490

 

Say SHLD ultimately keeps 20% of the 68 - that leaves 54.4 to be redeveloped and leased out, which works out to just over 11% of proxy group's total SF.

 

Will it take 20 years to develop and lease 11% of the quality SF outstanding? I have no idea.

 

Say Seritage redevelops and leases out half of the 54.4 within 5 years, and sells the remaining SF. Assume the 27.2 + the 13.6 leased to SHLD trades for $250/SF in the market, and it costs $80/SF to redevelop the 27.2, while the remaining 27.2 is sold for $150/SF.

 

The retained 40.8 would be worth $6.9B, net of redevelopment, and the sold portion $4.1B, for $11B in total. 5-year present value at a 10% discount rate is $6.83B today, or $64 per share.

 

Would purchasing the highest quality portion of SHLD's portfolio not be a slam dunk investment for a GGP or SPG? They could probably pay $300/SF and still generate a very healthy IRR from what I assume would be very strong lease rates in the highest quality malls.

[merkhet]

Chad, I think 20 years is a little bit extreme given the following quote from GGP's Q3:

 

Sandeep Lakhmi Mathrani - Chief Executive Officer and Director

 

And one last comment is we don't anticipate there should be any meaningful supply in the mall space. We may see a handful of malls being built in the next decade.

 

I think most people might be in agreement on the valuation of the A malls, but here's some additional commentary on the B malls...

 

Vincent Chao - Deutsche Bank AG, Research Division

It seems like a number of your sales and the number of competitors have been selling assets today in that B range here recently. Just curious if you're seeing a pickup in interest and if that's resulted in any cap recompression in that particular layer of the mall space?

 

Sandeep Lakhmi Mathrani - Chief Executive Officer and Director

And there is actually an interesting demand for that space and for those kinds of malls, and it comes from multiple sources, private equity money, small funds, entrepreneurial ownership. So we do see a demand. Our cap rates are depending on the asset, if it's -- it had definitely come down a good 100 basis points when we saw them a year ago. So there has been improvement than there is demand.

 

Furthermore, here's some information on cap rates on page 8:

http://annualreview.cushwake.com/downloads/04_cap_market_report.pdf

 

Cap rates for strip centers are compressing with Class A properties trading at going in cap rates of 5.5-6.3%, with an incremental 50 bp for secondary market assets of similar quality and 100 bp of incremental yield on class B properties. Class A malls are trading at 5.3-6.0% on average, with cap rates in the mid 4% range in markets such as Los Angeles. High street retail in luxury corridors in NYC are in high demand, trading in the sub-4% range. Cap rates for class B malls in the secondary markets are trading at a wider range of 7.4-8.3%.

 

So I'm not sure why you're using a 10 cap on Sears' core properties when a 7 cap is probably more appropriate for the 68 million square feet, which would result in a valuation of about $14 billion for Sears' trophy property.  This would equate to a valuation of about $205 per sq. ft.

 

As a reminder, my calculations of tax assessed values for Seritages' existing portfolio of Strip Centers & Box Splits is as follows:

 

Strip Centers: avg. $43.02 per sq. ft.

Box Splits: avg. $80.73 per sq. ft.

 

Here's how I've been thinking about the tax assessed values.  Take $43.02 per sq. ft. for example.  If we go the other way and infer a cap rate and a rental rate, we get $3 per sq. ft. at a 7 cap and $4 per sq. ft. at a 10 cap.

 

So what you have is a $14 billion asset before accounting for the following:

 

(1) The remaining 172 million sq. ft. of property

(2) Kenmore, Craftsman & Diehard -- I agree w/ Chad here that Craftsman is the most interesting

(3) Lands End

(4) Sears Auto Centers

(5) Sears Canada

 

A thought on the liabilities:

If you adjust for the DTA allowance of about $2.7 billion against their DTL, net out the inventory and leave the pension on its own (assuming interest rates continue to rise) -- your total liabilities come to around $4 billion.

 

Another way to look at the liabilities is the following:

Adjust for the DTA allowance of $2.7, net out the inventory and carve out the pension as above.  Total liabilities stand at $4 billion.

 

The pension stands at around $2.4 billion and will likely be $1.7 billion by year end once the interest rate rise is taken into account.  You can probably net the pension against LE ($800 million), Sears Auto ($300 million) and Sears Canada ($600 million) -- which gets you, oddly enough, to $1.7 billion.

 

Assume KCD is worth exactly zero dollars. Can you find someone to take 172 million sq. ft. off your hands for $4 billion?  (That comes out to about $23 per sq. ft.)

[Luke 532]

Taking all assets and liabilities at face value we have $2.327B in equity.  To get to $40/share that equity needs to be $4.240B, so we need to “find” $1.913B.  One way to get there is to find it via real estate.  We have $5.682B on the balance sheet for P&E.  Add $1.913B to $5.682B and if we can get a $7.595B that gets us to $40/share.

 

Curious if the huge amount of goodwill/intangibles on the balance sheet gives you any pause. Given your accounting background, I am guessing you would say that if they have not impaired it yet, then you feel comfortable with the number on the balance sheet. While shareholders equity is $2.3B, the intangible assets total over $3.2B, so tangible equity is negative to the tune of almost $1.0B. Pretty large number. Any concerns with this?

 

I've always been more of a fan of tangible assets over intangible assets.  I like stuff I can put my hands on.  With that said, I don't think the $3.237B in intangibles is that far off the mark.  Although brand value will get hit with declining sales in Sears retail, it would maintain (maybe increase) it's value with the success of sales at SHOS.  Perhaps that's one reason why Lampert is moving slowly... to preserve the value of the brands.  What are your thoughts on it?

 

I typically value intangibles at zero as one of the various ways to build in a cushion for myself. In the case of Sears and their ownership of KCD (I am especially keen on Craftsman -- Kenmore and Diehard not so much), that would make little sense so I cannot simply ignore it. Fortunately, SHLD actually discloses the net book value of the KCD IP ($1.0B). So for me, the remaining $2.2B is the concerning part.

 

Intangibles + goodwill

4.385B (Jan 2011)

3.778B (Jan 2012)

3.260B (Feb 2013)

 

Curious of everybody's thoughts on this, is it

(A) Lampert's being aggressive on writedowns to create NOL and offset taxes, or

(B) the brands, and other intangibles, have really been impaired to that extreme.

 

I tend to think it's (A) and, as a result, they are likely conservative in valuing intangibles + goodwill.  Thoughts?

[Sportgamma]

 

Intangibles + goodwill

4.385B (Jan 2011)

3.778B (Jan 2012)

3.260B (Feb 2013)

 

Curious of everybody's thoughts on this, is it

(A) Lampert's being aggressive on writedowns to create NOL and offset taxes, or

(B) the brands, and other intangibles, have really been impaired to that extreme.

 

I tend to think it's (A) and, as a result, they are likely conservative in valuing intangibles + goodwill.  Thoughts?

 

I would think that write down of deferred tax assets contributed significantly to those numbers:

 

In 2011, Sears recorded a $1.8 billion non-cash charge to write down its deferred tax assets. This was necessitated by an accounting rule test requiring that a valuation reserve be established when income has not been generated over a three-year cumulative period to support the deferred tax asset. However, the company stated in its just- released 2012 annual report that it believes that no economic loss has occurred. If the company is correct, then those net operating losses and tax benefits remain available to reduce future taxes on future income. So, as of 2012, Sears still had $679 million of deferred tax assets on its balance sheet and what it believes should be an additional $1.8 billion. Future after-tax income, then, could be far higher than would otherwise be anticipated. The company’s book value, now $3.2 billion, as against a stock market capitalization of $5.3 billion, would actually be $5 billion if the write-down of the tax asset were reversed.

http://www.horizonkinetics.com/docs/Q1_2013_Core%20Value%20Commentary.pdf

[peridotcapital]

 

Chad, I think 20 years is a little bit extreme given the following quote from GGP's Q3:

 

Sandeep Lakhmi Mathrani - Chief Executive Officer and Director

 

And one last comment is we don't anticipate there should be any meaningful supply in the mall space. We may see a handful of malls being built in the next decade.

 

Even for 68 million square feet? That's 3.4M sf Sears has to get leased every year. Think of that as 100 Whole Foods stores per year. It's the equivalent of leasing 70,000 sf every week for 20 consecutive years. That's a lot!

 

Cap rates for strip centers are compressing with Class A properties trading at going in cap rates of 5.5-6.3%, with an incremental 50 bp for secondary market assets of similar quality and 100 bp of incremental yield on class B properties. Class A malls are trading at 5.3-6.0% on average, with cap rates in the mid 4% range in markets such as Los Angeles. High street retail in luxury corridors in NYC are in high demand, trading in the sub-4% range. Cap rates for class B malls in the secondary markets are trading at a wider range of 7.4-8.3%.

 

So I'm not sure why you're using a 10 cap on Sears' core properties when a 7 cap is probably more appropriate for the 68 million square feet, which would result in a valuation of about $14 billion for Sears' trophy property.  This would equate to a valuation of about $205 per sq. ft.

 

I am assuming a normalizing interest rate environment over the next 10-20 years. If the 10-year bond will yield 2.5%-3.0% forever, then today's cap rates would make sense to me. But as interest rates rise, so will cap rates. I was thinking 9-10% would be a reasonable guess.

[bmichaud]

Does the opportunity to grow the Kenmore, Craftsman and Diehard brands outside of Sears not render the intangible asset calculation relatively moot? What if Home Depot, Lowes and Wal-Mart pick up these brands?

 

Just looked up where to find Diehard batteries within 50 miles of my house (Wal-Mart, Lowes and Home Depot all within range...):

 

Sears Auto x 3

Kmart x 3

 

Why can I not find Diehard batteries at Ace Hardware alongside the very prominent Craftsman display? Why cannot I not get them at WMT, HD or LOW?

 

Why can I not find Craftsman tools at WMT, HD or LOW?

 

Perhaps I'm talking out of my ass....but I see huge opportunity for these brands. Craftsman hasn't been around since 1927 for no reason, nor has Diehard been around since the '60s for no reason.

[Luke 532]

Does the opportunity to grow the Kenmore, Craftsman and Diehard brands outside of Sears not render the intangible asset calculation relatively moot? What if Home Depot, Lowes and Wal-Mart pick up these brands?

 

Most would agree with you, the upside could be extreme.  Personally, I'm just working on killing my thesis of a "reasonable worst case" scenario (non forced liquidation). 

 

I'm convinced the upside of SHLD is phenomenal.  It's the downside I've been focused on.  So far I've been unable to find a way to kill the "$40 downside valuation" thesis, but I'll be forever trying to kill it.

[merkhet]

Even for 68 million square feet? That's 3.4M sf Sears has to get leased every year. Think of that as 100 Whole Foods stores per year. It's the equivalent of leasing 70,000 sf every week for 20 consecutive years. That's a lot!

 

H&M is looking for 5 million sq. ft., UNIQLO is looking for 2 million sq. ft., Whole Foods is looking for 27 million sq. ft. Now I'm not saying that Sears gets all of that business, but I think 68 million sq. ft. is only a lot in the way that a million dollars is a lot of money when displayed as one dollar bills.

 

Or maybe a better analogy is that 653 million women looks like a lot when you don't consider the fact that there are 687 million men. (China's lopsided gender imbalance...)

 

Also, I think that bmichaud is correct in thinking that some of the Sears RE will, in fact, be "leased" to Sears -- so some adjustments need to be made to my thoughts re the liabilities, but it would lower the amount of square footage that needs to be leased out as well.  Let's also not forget possible sales too.

 

I am assuming a normalizing interest rate environment over the next 10-20 years. If the 10-year bond will yield 2.5%-3.0% forever, then today's cap rates would make sense to me. But as interest rates rise, so will cap rates. I was thinking 9-10% would be a reasonable guess.

 

I'm moderately amused that you're looking 10 years out on interest rates and five minutes out on Sears Canada. :P

[Guest wellmont]

Does the opportunity to grow the Kenmore, Craftsman and Diehard brands outside of Sears not render the intangible asset calculation relatively moot? What if Home Depot, Lowes and Wal-Mart pick up these brands?

 

Just looked up where to find Diehard batteries within 50 miles of my house (Wal-Mart, Lowes and Home Depot all within range...):

 

Sears Auto x 3

Kmart x 3

 

Why can I not find Diehard batteries at Ace Hardware alongside the very prominent Craftsman display? Why cannot I not get them at WMT, HD or LOW?

 

Why can I not find Craftsman tools at WMT, HD or LOW?

 

Perhaps I'm talking out of my ass....but I see huge opportunity for these brands. Craftsman hasn't been around since 1927 for no reason, nor has Diehard been around since the '60s for no reason.

 

because if you found them at ace you wouldn't go to kmart or sears to buy them. this is why it's So Hard to make deals on getting the brands in other places. no free lunch.

[Luke 532]

Funny conversation on StockTwits involving a very vocal SHLD bear (removed names for simplicity)...

 

SHLD bull: "@SHLDbear: I'm curious of your thoughts on Seritage, Ubiquity CE, and Reinsurance?"

 

SHLD bear: "@SHLDbull: Give me the ticker symbols"

 

SHLD bull: "@SHLDbear: Exactly as I thought. They're a part of Sears Holdings and u don't even know they exist!"

[peridotcapital]

I am assuming a normalizing interest rate environment over the next 10-20 years. If the 10-year bond will yield 2.5%-3.0% forever, then today's cap rates would make sense to me. But as interest rates rise, so will cap rates. I was thinking 9-10% would be a reasonable guess.

 

I'm moderately amused that you're looking 10 years out on interest rates and five minutes out on Sears Canada. :P

 

I have no idea what you mean. I've only owned Sears Canada since September but I will happily hold it for years to come if conditions warrant. I don't see how that has anything to do with valuing a real estate company's possible future stream of rental income. How do cap rates today have anything to do with potential lease income that will be generated in 5, 10, or 20 years? I wasn't valuing it as if Sears was going to sell the underlying property today. In that case, sure, I would use current cap rates.

 

[bmichaud]

Does the opportunity to grow the Kenmore, Craftsman and Diehard brands outside of Sears not render the intangible asset calculation relatively moot? What if Home Depot, Lowes and Wal-Mart pick up these brands?

 

Just looked up where to find Diehard batteries within 50 miles of my house (Wal-Mart, Lowes and Home Depot all within range...):

 

Sears Auto x 3

Kmart x 3

 

Why can I not find Diehard batteries at Ace Hardware alongside the very prominent Craftsman display? Why cannot I not get them at WMT, HD or LOW?

 

Why can I not find Craftsman tools at WMT, HD or LOW?

 

Perhaps I'm talking out of my ass....but I see huge opportunity for these brands. Craftsman hasn't been around since 1927 for no reason, nor has Diehard been around since the '60s for no reason.

 

because if you found them at ace you wouldn't go to kmart or sears to buy them. this is why it's So Hard to make deals on getting the brands in other places. no free lunch.

 

I'm thinking there are many out there, such as myself, who would never go to a Sears entity for those brands b/c they don't think to go to a Sears entity. I'll go to Home Depot to pick up whichever battery they carry. Now if HD starts carrying Diehard, suddenly there is a really good brand added to the mix.

 

My guess is the share Diehard would take from other batteries in Home Depot would match if not swamp the traffic Diehard gets via Sears/Kmart/Auto, even adjusting for ALL of the S/K/A traffic going to zero.

[merkhet]

I have no idea what you mean. I've only owned Sears Canada since September but I will happily hold it for years to come if conditions warrant. I don't see how that has anything to do with valuing a real estate company's possible future stream of rental income. How do cap rates today have anything to do with potential lease income that will be generated in 5, 10, or 20 years? I wasn't valuing it as if Sears was going to sell the underlying property today. In that case, sure, I would use current cap rates.

 

You wrote at one point that you're only willing to give Sears Canada a valuation of $600 million for Sears Holdings because that's what it currently trades for on the open market. (e.g. five minutes from now)

[CorpRaider]

Ace does carry craftsman.  So does costco.  LOW has publicly expressed an interest in carrying them in connection with the OSH acquisition.

[peridotcapital]

I have no idea what you mean. I've only owned Sears Canada since September but I will happily hold it for years to come if conditions warrant. I don't see how that has anything to do with valuing a real estate company's possible future stream of rental income. How do cap rates today have anything to do with potential lease income that will be generated in 5, 10, or 20 years? I wasn't valuing it as if Sears was going to sell the underlying property today. In that case, sure, I would use current cap rates.

 

You wrote at one point that you're only willing to give Sears Canada a valuation of $600 million for Sears Holdings because that's what it currently trades for on the open market. (e.g. five minutes from now)

 

Seems a bit misleading without a little context, but I see how you might see a disconnect.

 

We were talking about trying to quantify potential downside of buying SHLD at current prices. In doing so, one assumption I would make would be that my thesis on Sears Canada (intrinsic value being above the market price) turned out to be wrong. So yes, I will use the current market price for Sears Canada in certain scenarios when trying to peg a valuation on SHLD (I do not have just a single valuation model in an uncertain situation like this one).

[bmichaud]

Why can I not find Diehard batteries at Ace Hardware alongside the very prominent Craftsman display? Why cannot I not get them at WMT, HD or LOW?

 

 

I was saying I'd like to see diehard alongside craftsman at ace. The craftsman displays at ace are phenomenal! I almost posted a pic here the other day lol.

[Guest wellmont]

I suspect not many buy batteries at ace. first not many buy them in the first place. most people get a battery at a service center when they get oil change and they tell you your battery is low. The car nuts go to Kragens / Autozone or Sears. shld has been working on wider distribution of their brands for years now. It's not a simple calculus. These are slow growing brands and essentially a zero sum game for shld.

[ValueBuff]

I know a rising interest rate will help with the sHLD pension obligation, but how will it effect their lease rates?

 

Does sq ft. on commerical leases go up when rates go up?  or is there no correlation and it depends on occupancy?

 

Thanks for the feedback.  not sure if this adds value or not to the equation.

[constructive]

I know a rising interest rate will help with the sHLD pension obligation, but how will it effect their lease rates?

 

Does sq ft. on commerical leases go up when rates go up?  or is there no correlation and it depends on occupancy?

 

Thanks for the feedback.  not sure if this adds value or not to the equation.

 

Rising interest rates reduce the value of below market leases, and to a lesser extent owned property.

 

Also reduces the price of their debt, which is good if they can buy some of it back, but bad if they have to roll into higher yield debt in a few years.

[merkhet]

I know a rising interest rate will help with the sHLD pension obligation, but how will it effect their lease rates?

 

Does sq ft. on commerical leases go up when rates go up?  or is there no correlation and it depends on occupancy?

 

Thanks for the feedback.  not sure if this adds value or not to the equation.

Rising interest rates reduce the value of below market leases, and to a lesser extent owned property.

 

Also reduces the price of their debt, which is good if they can buy some of it back, but bad if they have to roll into higher yield debt in a few years.

 

I am assuming a normalizing interest rate environment over the next 10-20 years. If the 10-year bond will yield 2.5%-3.0% forever, then today's cap rates would make sense to me. But as interest rates rise, so will cap rates. I was thinking 9-10% would be a reasonable guess.

 

This is a good question, ValueBuff, but the answer is far from clear.

 

http://www.jpmorganinstitutional.com/blobcontent/520/859/1323363596727_II_Real%20Estate%20What%20Higher%20Interest%20Rates%20Mean_r9.pdf

 

http://www.forbes.com/sites/billconerly/2013/07/02/commercial-property-values-with-rising-interest-rates/

 

http://www.investmentmanagement.prudential.com/documents/pimusa/Conundrum_PRU.pdf

 

https://www.tiaa-cref.org/public/pdf/C10181_Real%20Estate_Cap%20Rates%20Rising.pdf

 

https://www.reis.com/site_file_download.cfm?fileID=13924

 

It seems that it depends on the reason for interest rates rising. (This reminds me somewhat of the discussion people have had -- sporadically -- on the effect of interest rate increases in banking.  The BAC thread has a ton of back and forth on this a year ago.)

 

In general, interest rate increases have the effect of increasing the cap rates, as Chad stated.  Usually, cap rates are priced based on a spread to Treasury rates, so as those rise, cap rates also rise.  However, that's only a first pass analysis.

 

The second pass is whether rental rates and occupancy rates stay the same when interest rates increase.  If the increase is due to a stronger economy, it's possible that rental rate increases and lower occupancy rates actually increase valuations.

 

For instance, if rental rates are $15 right now @ a 7 cap, that's a valuation of $214 per sq. ft.  However, if rental rates go to $30, even at a 10 cap, you'll see a higher valuation of $300 per sq. ft. despite the increase in the cap rate.