SHLDQ - Sears Holdings Corp

[Luke 532]

Eric (and others), so is the following quote by Lampert, where he says "closing costs" - are those costs associated with just selling the stores, and not also closing them?  I would think his statement would involve both events (closing and selling).  And I would think "closing costs" covered any advertisting/reaching out to sell the stores, any "liquidation sale" ads, hiring a sales agent (if needed), consultants for the best way to go about closing/selling, etc. 

 

Lampert in February 2013 letter to shareholders:

"...we are usually able to generate significant cash from the net inventory invested in the stores, as the net inventory proceeds typically exceed the severance and closing costs."

 

And he says the net inventory (alone) covers closing costs and severance.  That would be over and above any gains on the value of the real estate.

[ERICOPOLY]

And he says the net inventory (alone) covers closing costs and severance.  That would be over and above any gains on the value of the real estate.

 

Inventory is an asset.  It declines when the inventory is sold, and at this point is converted to an offsetting amount of cash if the inventory is sold at carrying value.  There is net cash left over after paying off the financing used to purchase a portion of the inventory.  But this net cash disappears when paying the closing costs and severance.

 

At that point the assets on the balance sheet suffers a decline.  The inventory is gone, and so is the net cash that was generated from selling the inventory.

 

So my (restated) question is, to what degree does recapturing the "hidden" value of the real estate (upon sale) exceed this new hole in the balance sheet?

 

[ERICOPOLY]

Expressed differently:

 

Hidden liability:

cost of closing stores and severing employees

 

Hidden asset:

undervalued real estate

 

What is the net difference between the two? 

[Luke 532]

At that point the assets on the balance sheet suffers a decline.  The inventory is gone, and so is the cash that was generated from selling the inventory.

 

Yes, of course the assets decline, but the liabilities of closing stores decline as well.  Are they dollar-for-dollar?  I have no idea. 

 

Lampert February 2013 letter...

"First, we no longer suffer the operating losses of the money-losing stores. Second, in most cases, we are no longer penalized by the rating agencies for the lease expense (or obligation) associated with those stores."

[JRH]

Expressed differently:

 

Hidden liability:

cost of closing stores and severing employees

 

Hidden asset:

undervalued real estate

 

What is the net difference between the two?

 

When he says:

 

"...we are usually able to generate significant cash from the net inventory invested in the stores"

 

I take "net inventory invested" to mean, essentially, that he is referring to cash generated net of the cost of the inventory.  Since the cost of the inventory is the accounting entry, you would also list "gain on inventory" as a hidden asset.

 

Then, he's saying the "gain on inventory" hidden asset > "cost of closing stores and severing employees" hidden liability.

 

"Undervalued real estate" hidden asset is all gravy, then.

 

Just my take.

 

EDIT: I am rather glad it was brought up, though, because it's not at all clear if this is correct...

[ERICOPOLY]

I take "net inventory invested" to mean, essentially, that he is referring to cash generated net of the cost of the inventory.  Since the cost of the inventory is the accounting entry, you would also list "gain on inventory" as a hidden asset.

 

We have very different understandings.

 

When he says "net cash", I believe he means how much cash is left after paying down the credit lines that are secured by the inventory.

 

 

Okay, so then there is your interpretation:  I will ask a question... 

If they can sell inventory at a profit so large as to fund all of the expenses of shutting down the store, employee severance, etc... then why don't they just do this all the time and not close the store?  I mean that sounds like a good businesses if you can turn over your entire inventory in a short period of time at such a profit level.

 

 

[ERICOPOLY]

 

Yes, of course the assets decline, but the liabilities of closing stores decline as well.  Are they dollar-for-dollar?  I have no idea. 

 

Lampert February 2013 letter...

"First, we no longer suffer the operating losses of the money-losing stores. Second, in most cases, we are no longer penalized by the rating agencies for the lease expense (or obligation) associated with those stores."

 

He isn't talking about an offsetting liability on the balance sheet when he talks about operating losses.

 

I'm just talking about the balance sheet here.

 

We've all heard the pitch from Berkowitz about how GAAP is insane because of the value of Manhattan when the Pilgrims came ashore.

 

But when is the last time you heard Berkowitz pound the table that GAAP is equally insane for not recording the anticipated cost of shutting down stores and letting go of employees as a liability?

 

[wisdom]

Eric - the way I read it is the same as Luke

 

net inventory proceeds covers all closing costs and proceeds from RE/cancelling leases are all passed onto SHLD.

 

Not 100% of the inventory is financed. Thus, the difference would be used to pay off the closing costs.

 

If you were to assume that the liquidation of the inventory covers all costs associated with closing you can work with the assumption that you get all the RE proceeds.

 

Not sure if this helps.

[JRH]

If they can sell inventory at a profit so large as to fund all of the expenses of shutting down the store, employee severance, etc... then why don't they just do this all the time and not close the store?  I mean that sounds like a good businesses if you can turn over your entire inventory in a short period of time at such a profit level.

 

Yes, he probably would not have referenced "cash" if my interpretation was correct.  Thanks for the learning opportunity.

 

So, the cost to close the store is typically less than the equity position of the associated inventory that is liquidated.

[wisdom]

Eric - read your more recent post - your interpretation seems to be correct.

[ERICOPOLY]

Eric - the way I read it is the same as Luke

 

net inventory proceeds covers all closing costs and proceeds from RE/cancelling leases are all passed onto SHLD.

 

Not 100% of the inventory is financed. Thus, the difference would be used to pay off the closing costs.

 

If you were to assume that the liquidation of the inventory covers all costs associated with closing you can work with the assumption that you get all the RE proceeds.

 

Not sure if this helps.

 

You stated mostly what I too believe and understand.

 

Here is the part that I agree with:

 

1)  Not 100% of the inventory is financed. Thus, the difference would be used to pay off the closing costs.

- completely agree

2)  net inventory proceeds covers all closing costs and proceeds from RE/cancelling leases are all passed onto SHLD.

- completely agree

3)  If you were to assume that the liquidation of the inventory covers all costs associated with closing you can work with the assumption that you get all the RE proceeds.

- completely agree

 

 

Now, here is where my point is at:

 

You might be making a gain on the real estate sale that went entirely to SHLD, but however you made a loss on the closing of the store.  Whether or not the loss was funded from cash Eddie borrowed from his grandmother, or whether they sold the Queen Mary to fund the loss... doesn't really matter.  Do the gains from the real estate sale and the losses from employee severance cancel themselves out?

 

Or lets frame it differently to completely avoid confusion...

 

Suppose on the next store they close down, instead of selling the inventory they move it to another Sears location across town.  Now, do the profits from selling the store cover the costs of closing it and employee severance?

 

[ERICOPOLY]

Eric - read your more recent post - your interpretation seems to be correct.

 

 

Ahhhh.... got it.  Well, sorry for my latest reply then which beat a dead horse.

[CorpRaider]

Yeah, my recollection is that Lampert has emphasized that, while closing stores is not his preferred course of action (obviously turning around the store into a thriving retail operation is better for long-term profit potential), the event is cash flow positive for holdings.  Probably because the losing store isn't sitting there sucking cash for labor and overhead and sitting on wasting inventory. 

[Luke 532]

Now, do the profits from selling the store cover the costs of closing it and employee severance?

 

OK, I hear you now.  Maybe I didn't have enough coffee this morning - that's the fuel I need to get my brain working.

 

So, completely excluding inventory from the conversation, you're asking will the gross profit (if any) from selling the store exceed the cost of closing it and paying severance on that specific store.  I don't have specific numbers but I would imagine that the cost to close it, and severance, wouldn't be very high... at least not a big enough amount to offset the gains from selling the store at today's price vs. what was paid for it.

 

But, of course, the question is HOW MUCH does it eat away at the overall asset value of SHLD?

[ERICOPOLY]

A bit of info from the 2012 annual report.  This is information regarding KMart's store closings. 

 

It seems to me at first glance that the "hidden liability" exceeds the "hidden asset" by a wide margin.

 

For 2012 we have $48 million in gains but $85 million in severance costs.  Then there is a $10 million impairment charge but I don't understand what that is -- some sort of leasehold improvement or something that was written down?

 

starting at bottom of page 33:

 

Gain on Sales of Assets Kmart recorded a total net gain on sales of assets of $37 million and $34 million in 2012 and 2011, respectively. The gains on sales of assets in 2012 included a gain of $11 million recognized on the sale of one store while 2011 included a gain of $12 million recognized on the sale of one store.

 

Operating Income (Loss) Kmart recorded operating income of $5 million in 2012 as compared to an operating loss of $34 million in 2011. This improvement was primarily driven by the improvement in gross margin rate and a decrease in selling and administrative expenses which more than offset the above noted decrease in revenues. Operating income in 2012 included expenses related to store closing and severance costs of $85 million and store impairments of $10 million as well as a gain of $11 million related to the sale of one store. Kmart's operating loss for 2011 included expenses related to store impairments of $15 million, store closing and severance costs of $76 million as well as a gain of $12 million related to the sale of one store.

 

 

[ERICOPOLY]

regarding the 2012 annual report:

 

see page 26:

 

Domestic pension expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165

 

 

then skip to page 36:

 

We recorded total gains on sales of assets of $261 million in 2012 and $30 million in 2011 which were primarily attributable to several real estate transactions.

 

Sears Domestic’s operating loss included expenses related to domestic pension plans and store closings and severance of $674 million and $242 million in 2012 and 2011, respectively,

 

alright... now...

 

Gain of $261 million on selling the real estate versus store closing and severance expense of roughly $500 million (after subtracting out the domestic pension expense which I assume is unrelated to the store closings).

 

So is that $500 million expense really attributed to selling the Sears stores?  If so it's vastly greater than the $261 million gain from selling the real estate.  Ouch!  Am I making some sort of mistake here?

 

Perhaps pension severance costs were thrown in there? but it doesn't add up as pension settlements were $455m.  Add that to the $165m domestic pension expense and it come to $620m just for pensions.  Okay, then that leaves only $54m for store closings.  But then a bunch of their sales they weren't expected to surrender the premises for up to 18 months afterwards (delaying the expenses).  So they established a "closed store reserve and allowance" of  $140 million to cover the costs that would be realized in 2013 (see page 26).

 

Take that reserve and add the $54m to it, and we get possibly $194m cost of store closings and severance.  Weigh that against the sale gain of $261 million.  So there was a little bit of hidden value there, but not that much.

[ERICOPOLY]

Sears Canada fared better (page 39 of 2012 AR):

 

We recorded a total gain on sales of assets of $170 million in 2012

Operating loss in 2012 included expenses of $20 million related to store closings and severance,

[ERICOPOLY]

For 2012 real estate transactions...

 

Sears Domestic $67m gain (after netting out cost of severance and closings)

KMart    $37m loss (after netting out cost of severance and closings)

 

$30 million of "hidden value" unlocked by putting the Sears Domestic and KMart transactions together.

 

Unfortunately SHLD doesn't own all of this one:

Sears Canada  $150m gain (after netting out cost of severance and closings)

 

So in total, $106.5m unlocked "hidden value" in 2012 for SHLD shareholders (assuming 51% ownership of Sears Canada).

 

 

EDIT:  IMHO this isn't a fast enough pace to justify the lofty valuations that I have heard the bulls talking about.  Remember $100m unlocked 7 years from now is only worth slightly more than $50m in today's dollars with a 10% discount rate.

[Luke 532]

 

EDIT:  IMHO this isn't a fast enough pace to justify the lofty valuations that I have heard the bulls talking about.  Remember $100m unlocked 7 years from now is only worth slightly more than $50m in today's dollars with a 10% discount rate.

 

Yes, but the vast majority of these stores were likely their worst performing stores.  To get any profits from the under-performing stores is not a bad situation at all to be in (plus it reduces on-going liabilities tied to the lease and other operating costs).  And that's not factoring in any profits from the inventory liquidation.

[krazeenyc]

Eric, Maybe I misread what you wrote. The $140 million closed store reserve is for Kmart + Sears + Sears Canada 76 for Kmart, 44 for sears, 20 for sears Canada. Right?

[wisdom]

hypothetical exercise:

 

I have a business that owns 10 stores that are operating at a loss.

 

Lets assume only 2 are profitable and the other 8 incur losses.

 

If I can find uses for the other 8 that lead to them operating at a profit (datacentres, lease to others, real estate development, etc) to generate high enough returns - suddenly the business would look pretty damn good.

 

I also have the option: that I cash out of the very worst stores without incurring any losses and profitable business shows up.

 

Eddie has stated that he believes a good business should generate 11% on ROIC. I believe that is what will be attempted.

 

Remains to be seen how this plays out. I believe Eddie does what he says while keeping all the options open. This creates a lot of uncertainty for most.

[ERICOPOLY]

Eric, Maybe I misread what you wrote. The $140 million closed store reserve is for Kmart + Sears + Sears Canada 76 for Kmart, 44 for sears, 20 for sears Canada. Right?

 

Ah, you're right.

[ERICOPOLY]

 

EDIT:  IMHO this isn't a fast enough pace to justify the lofty valuations that I have heard the bulls talking about.  Remember $100m unlocked 7 years from now is only worth slightly more than $50m in today's dollars with a 10% discount rate.

 

Yes, but the vast majority of these stores were likely their worst performing stores.  To get any profits from the under-performing stores is not a bad situation at all to be in (plus it reduces on-going liabilities tied to the lease and other operating costs).  And that's not factoring in any profits from the inventory liquidation.

 

Well what I'm speaking about is when Berkowitz claims the real estate is worth $160 or so.  That type of valuation is pointless exercise unless they are actually going to net $160 per share from selling it today (after accounting for the costs of severance and store closures).  I'm 100% certain that it won't happen.  Suppose it takes years to happen... then it must be discounted to the present.

 

And like you say, they seem to be selling the underperforming stores.  In other words, they intend to keep the performing stores as going concerns.  Thus the liquidation simply "ain't gonna happen".  And thus Berkowitz' real estate thesis seems pointless.

 

Or maybe the real estate thesis is just to serve as a proxy for what the whole enchilada would be worth if they could turn the operating performance around to the degree that the retail operations perform as profitably as what a REIT would get through lease income of those same properties?  In which case we are depending on a revival of Sears and KMart?

[wisdom]

Bruce only talks about real estate as he is referring to the margin of safety. People are reading too much into his reference to the real estate value.

 

I do not believe that Eddie would commit to a masterplan. Otherwise he would not have had the flexibility to deal with the GFC in 2008.

 

The only thing he did commit to was reducing the share count and he had laid out a plan all the way until 2010 and he did reduce the share count to 110 mil by 2010.

[Luke 532]

Well what I'm speaking about is when Berkowitz claims the real estate is worth $160 or so.  That type of valuation is pointless exercise unless they are actually going to net $160 per share from selling it today (after accounting for the costs of severance and store closures).  I'm 100% certain that it won't happen.  Suppose it takes years to happen... then it must be discounted to the present.

 

And like you say, they seem to be selling the underperforming stores.  In other words, they intend to keep the performing stores as going concerns.  Thus the liquidation simply "ain't gonna happen".  And thus Berkowitz' real estate thesis seems pointless.

 

I agree in part.  I don't think (and never have) that a full liquidation would take place.  But I don't think his estimates are pointless.  It gives us a general framework as to the value of the real estate portfolio.  For example, from mid-2008/early-2009 to late-2012 Berkowitz estimates the value of real estate has nearly doubled.  2008/2009 he valued the real estate (based on tax assessments) at $80 on the low-end, and later in 2012 at $160.  Let's take the lower of those two ($80) and cut it in half - that still gives us $40 of real estate per share... and represents just 1/4 of the value Berkowitz estimated less than a year ago.  I've always considered Berkowitz a manager that likes to operate with a wide margin of safety... and valuing the real estate at 1/4 of his valuation is probably a ludicrously safe estimate. 

 

November 2012

http://finance.fortune.cnn.com/2012/11/26/bruce-berkowitz-fairholme/

"The value of Sears (SHLD) [which trades near $60] would be over $160 a share if the land on the books was fully valued."

 

March 2009 ("last summer" so that is mid-2008):

http://seekingalpha.com/article/319106-tracking-bruce-berkowitz-s-fairholme-fund-holdings

"Last summer, we spent a tremendous amount of time going to all the tax collectors’ offices around the U.S. trying to get the tax value of Sears and Kmart properties — and we came up with numbers that ranged from between $80 and $90 per share."