SHOS - Sears Hometown and Outlet Store

[accutronman]

Forget SHLD. If you want to play Sears, this is the way to go. Up huge for the YTD

[muscleman]

Forget SHLD. If you want to play Sears, this is the way to go. Up huge for the YTD

 

Do you have an investment thesis here?

SHOS is not a bad company, but is it undervalued?

[stahleyp]

I have a small piece. I bought some additional rights back around Sept or so. Up around 110% so far. Can't complain. :)

[JAllen]

Forget SHLD. If you want to play Sears, this is the way to go. Up huge for the YTD

 

Are you saying we should purchase SHOS because it's gone up in price and we should ignore SHLD because it hasn't?

[AchilliesValue]

I'll admit I completely missed the boat on this one so maybe I'm just bitter but it doesn't seem cheap anymore. At the time of the rights offering they hid cash through spinning the company with a working capital balance that was not nearly as optimized as a retailer should be.

 

But buying now at ~12X EBITDA I think your banking on them vastly growing the Outlet concept. I'll agree it's very a viable concept, asset light, arguably at a cyclical low point, and you have a proven capital allocator at the helm. But I think there are cheaper opportunities. I could be dead wrong on this (again) but its really hard to tell as Lambert is not very transparent with shareholders as to his intentions. It's on my watch list and I'd get very interested if it gets cheaper.

[LC]

At the time of the rights offering they hid cash through spinning the company with a working capital balance that was not nearly as optimized as a retailer should be.

Can you expand on this? What do you mean by optimized? That is, how much cash should SHOS have had to work with, and why?

[AchilliesValue]

At the time of the rights offering they hid cash through spinning the company with a working capital balance that was not nearly as optimized as a retailer should be.

Can you expand on this? What do you mean by optimized? That is, how much cash should SHOS have had to work with, and why?

 

So if you look at the Prospectus http://www.sec.gov/Archives/edgar/data/1548309/000119312512385596/d337523d424b3.htm they state that

In connection with the separation transactions we expect to enter into an asset-based senior secured revolving credit facility, or the “Senior ABL Facility,” which we expect will provide for aggregate maximum borrowings (subject to availability under a borrowing base) of $250 million. Prior to the separation, we expect to draw $100 million under the Senior ABL Facility to pay a cash dividend to Sears Holdings.

 

It sounds like ok well add $100 mil to the enterprise value as they will have that debt outstanding but... if you look at the balance sheet

 

Accounts Receivable $9 Million

Inventory $393.7 Million

Merchandise Payables $17.2 Million

 

Compare that to $1820.5 Million in COGS and that translates to Days Inventory of 78.9 vs Days Payable of 3.4.  Seem a little out of whack?  Now compare that with the 10-K they filed recently.

 

Accounts Receivable $11.0 Million

Inventory $428.4 Million

Total Payables 131.3 Million

 

Again compare to $1840.2 Million in COGS and Days Inventory has increased (but the store count is up) to 85.0 vs Days Payable of 7.1 now.  Still low but over 100% increase.  Long term debt that we expected to be $100 mil is zero as it was mostly funded from working capital adjustments.

 

As far as how much cash they have available its tough to say.  There aren't really any direct comps.  The best would be Ace and True Value but they're not public and as the store mix shifts toward more Outlets those aren't as appropriate.  Neither is TJX as they are mostly clothing vs appliances.  Also as the shift to franchises continues you'd expect lower Working Capital requirements.  I looked at Home Depot, Lowes, TJX, and HHGregg just for kicks and this is what I got.

 

Lowes

Days Payable: 58.6

Days Inventory: 94.5

 

Home Depot

Days Payable: 66.2

Days Inventory: 79.9

 

HHGregg

Days Payable: 41.9

Days Inventory: 65.5

 

TJX

Days Payable: 74.1

Days Inventory: 59.4

 

Hypothetically take the mean of the Days Payable and its 60.2 Days.  If SHOS were to go from 7.1 Days to 60.2 Days accounts payable would go to $303.5 Million.  Compare that with the current A/P of 131.3 million and that means we'd have an extra $172.2 Million in cash.  Take that out of the enterprise value and it looks better with EV / EBITDA of 10X but still not that cheap.  And you need to remember that SHLD is one of their primary suppliers so you can't count on the same days payable as the peers.  However think about what this exercise looked like when the stock was $15 or even $30.

[LC]

Brilliant exercise! Thank you for the time you took to explain that, I just learned at least three new things to keep in mind. Very interesting the ways the parent co can set spinco into motion from the start!

 

 

[tooskinneejs]

Does "building cash" by not paying your payables really provide anything other than a one-time benefit in the period in which vendor payments are deferred?

[CorpRaider]

The spin-off of this one kind of muddled my SHLD thesis.  If one thinks the end game is a holding compan with a (hopefully successful) retail operation, a reit sub, an appliance brand licensing and/or manufacturing sub, an apparel licensing or manufacturing sub, a craftsman licensing and/or manufacturing sub, etc...I don't see how this fits in unless the ESL shares are exchanged for SHLD shares in the future or something.  Its just weird to me to have sears outlets not be majority directly owned and controlled by sears.

[jay21]

The spin-off of this one kind of muddled my SHLD thesis.  If one thinks the end game is a holding compan with a (hopefully successful) retail operation, a reit sub, an appliance brand licensing and/or manufacturing sub, an apparel licensing or manufacturing sub, a craftsman licensing and/or manufacturing sub, etc...I don't see how this fits in unless the ESL shares are exchanged for SHLD shares in the future or something.  Its just weird to me to have sears outlets not be majority directly owned and controlled by sears.

 

Yes.  I agree with this.  I asked this question in the OSH thread after its drop:

 

Without being results oriented, I am curious to see how many people own SHLD and the spin off companies.  Isn't there a little bit of a broken thesis if you own both?  Wasn't the line of thinking that SHLD would liquidate the poorer stores and keep the profitable ones?  How was this reconciled?  That you got a cheap enough price or the spins were "non-core"?

 

My thoughts are, if the spin is a good asset, why isn't ESL keeping it in Sears?  I think if you can satisfactorily answer that only then do these spins become investable, imo.

[stahleyp]

The spin-off of this one kind of muddled my SHLD thesis.  If one thinks the end game is a holding compan with a (hopefully successful) retail operation, a reit sub, an appliance brand licensing and/or manufacturing sub, an apparel licensing or manufacturing sub, a craftsman licensing and/or manufacturing sub, etc...I don't see how this fits in unless the ESL shares are exchanged for SHLD shares in the future or something.  Its just weird to me to have sears outlets not be majority directly owned and controlled by sears.

 

Yes.  I agree with this.  I asked this question in the OSH thread after its drop:

 

Without being results oriented, I am curious to see how many people own SHLD and the spin off companies.  Isn't there a little bit of a broken thesis if you own both?  Wasn't the line of thinking that SHLD would liquidate the poorer stores and keep the profitable ones?  How was this reconciled?  That you got a cheap enough price or the spins were "non-core"?

 

My thoughts are, if the spin is a good asset, why isn't ESL keeping it in Sears?  I think if you can satisfactorily answer that only then do these spins become investable, imo.

 

The way I thought about it was that if ESL was oversubscribing to the rights, Eddie must have seen a lot of value in it.

[CorpRaider]

Yeah that was clearly the right call at the time.  I blew it even though I remember Sara Lee did the same thing with Coach a while back.  I only nibbled at both.  I was more focused on how ESL controlling SHOS as a distinct enterprise impacts my confidence in whether I know what the heck his longer term plan is for SHLD.

[AchilliesValue]

Does "building cash" by not paying your payables really provide anything other than a one-time benefit in the period in which vendor payments are deferred?

 

Yes and no. Think about it in terms of ROIC. If sales continue to grow then the payables provide in essence a free form of financing. Think in terms of Walmart and Amazon. They're so large and can stretch their supplies so much that most of their operations are financed by their suppliers. As long as the payables don't decrease then in essence they have a cost of capital of near zero.

 

Also in regards to the broken SHLD thesis I agree this seem a bit alarming. The only thing I can think of is that the parent needed the capital raised from the rights offering and Lambert devised a spinoff where he could continue to capture the upside. As SHLD closes stores SHOS opens them in its place.

[stahleyp]

Kinda funny that the stock is down about 20% since the original post.  :P

[muscleman]

At the time of the rights offering they hid cash through spinning the company with a working capital balance that was not nearly as optimized as a retailer should be.

Can you expand on this? What do you mean by optimized? That is, how much cash should SHOS have had to work with, and why?

 

So if you look at the Prospectus http://www.sec.gov/Archives/edgar/data/1548309/000119312512385596/d337523d424b3.htm they state that

In connection with the separation transactions we expect to enter into an asset-based senior secured revolving credit facility, or the “Senior ABL Facility,” which we expect will provide for aggregate maximum borrowings (subject to availability under a borrowing base) of $250 million. Prior to the separation, we expect to draw $100 million under the Senior ABL Facility to pay a cash dividend to Sears Holdings.

 

It sounds like ok well add $100 mil to the enterprise value as they will have that debt outstanding but... if you look at the balance sheet

 

Accounts Receivable $9 Million

Inventory $393.7 Million

Merchandise Payables $17.2 Million

 

Compare that to $1820.5 Million in COGS and that translates to Days Inventory of 78.9 vs Days Payable of 3.4.  Seem a little out of whack?  Now compare that with the 10-K they filed recently.

 

Accounts Receivable $11.0 Million

Inventory $428.4 Million

Total Payables 131.3 Million

 

Again compare to $1840.2 Million in COGS and Days Inventory has increased (but the store count is up) to 85.0 vs Days Payable of 7.1 now.  Still low but over 100% increase.  Long term debt that we expected to be $100 mil is zero as it was mostly funded from working capital adjustments.

 

As far as how much cash they have available its tough to say.  There aren't really any direct comps.  The best would be Ace and True Value but they're not public and as the store mix shifts toward more Outlets those aren't as appropriate.  Neither is TJX as they are mostly clothing vs appliances.  Also as the shift to franchises continues you'd expect lower Working Capital requirements.  I looked at Home Depot, Lowes, TJX, and HHGregg just for kicks and this is what I got.

 

Lowes

Days Payable: 58.6

Days Inventory: 94.5

 

Home Depot

Days Payable: 66.2

Days Inventory: 79.9

 

HHGregg

Days Payable: 41.9

Days Inventory: 65.5

 

TJX

Days Payable: 74.1

Days Inventory: 59.4

 

Hypothetically take the mean of the Days Payable and its 60.2 Days.  If SHOS were to go from 7.1 Days to 60.2 Days accounts payable would go to $303.5 Million.  Compare that with the current A/P of 131.3 million and that means we'd have an extra $172.2 Million in cash.  Take that out of the enterprise value and it looks better with EV / EBITDA of 10X but still not that cheap.  And you need to remember that SHLD is one of their primary suppliers so you can't count on the same days payable as the peers.  However think about what this exercise looked like when the stock was $15 or even $30.

 

Thank you for this analysis!

So of the 4 stores that you listed above, only TJX has days payable greater than days inventory, and all other 3 companies have days payable less than days inventory. This means only TJX is able to get free financing from suppliers, right?

 

Yeah from this point of view, since SHOS's supplier is SHLD, it is unlikely that the days payable will go from 7 days to 60 days.

If the stock price drops back to $30, this will be an interesting stock, right? :)

[Sunrider]

Folks,

 

Quick question re muddle theses - I've had a brief scan through form 13filings on Edgar and it seems to me that Eddie has sold down part of his SHOS stake since December? Does this, in your mind, indicate that SHLD is more attractive over SHOS?

 

Thanks - C.

 

[BTShine]

Folks,

 

Quick question re muddle theses - I've had a brief scan through form 13filings on Edgar and it seems to me that Eddie has sold down part of his SHOS stake since December? Does this, in your mind, indicate that SHLD is more attractive over SHOS?

 

Thanks - C.

 

I saw that, too.  Has anyone found any filings related to his sale, or transfer of these shares?

 

 

[krazeenyc]

The spin-off of this one kind of muddled my SHLD thesis.  If one thinks the end game is a holding compan with a (hopefully successful) retail operation, a reit sub, an appliance brand licensing and/or manufacturing sub, an apparel licensing or manufacturing sub, a craftsman licensing and/or manufacturing sub, etc...I don't see how this fits in unless the ESL shares are exchanged for SHLD shares in the future or something.  Its just weird to me to have sears outlets not be majority directly owned and controlled by sears.

 

Yes.  I agree with this.  I asked this question in the OSH thread after its drop:

 

Without being results oriented, I am curious to see how many people own SHLD and the spin off companies.  Isn't there a little bit of a broken thesis if you own both?  Wasn't the line of thinking that SHLD would liquidate the poorer stores and keep the profitable ones?  How was this reconciled?  That you got a cheap enough price or the spins were "non-core"?

 

My thoughts are, if the spin is a good asset, why isn't ESL keeping it in Sears?  I think if you can satisfactorily answer that only then do these spins become investable, imo.

 

The way I thought about it was that if ESL was oversubscribing to the rights, Eddie must have seen a lot of value in it.

 

The reason ESL oversubscribed in the spin off is that based on the way he structured it -- it was super cheap and essentially guaranteed money.  I wasn't involved in SHLD or SHOS at the time, but I remember reading up the sec filings -- and basically I remember SHLD shareholders were in essence paying about $15 a share for SHOS shares (please if I'm wrong correct me) -- I remember thinking SHOS was worth at least $30 -- maybe more.

[GrizzlyRock]

Hey guys I had a call with the company this week regarding a few questions I had after browsing the 10Q.

 

Gross Margin

 

1. Please comment on what the reclassified outlet distribution costs consist of.  Why were they reclassified from SG&A to COGS this year? Was this related to the two additional franchised Sears Outlets?

• Historically a number of stores (in 10K) asterisk combined selling store and distribution center – but now that SHOS wants to franchise many of these stores they are putting the costs in COGS where they belong

•Cleaning things up to franchise.  By separating distribution costs from store cost the actual cost of sales is “lined up economically with GAAP”

• This is a “One time change” and all the locations which have this DC/store sharing have been reclassified. SHOS just decided not to restate previous financial statement for the reclassification.

 

Author’s note: So per the above, the gross margin miss was better than it appeared due to the reclass.  As such, Outlet margin was “only” down 17.0% instead of the 24.7% it appeared. 

 

So overall margin was down 6.9% instead of 9.0%.  Either way, with merchandise margin contributing nearly half of the GP decline it’s tough to make positive commentary.  To be specific, of the 6.9% decline from $156.4 to $148.4: 48% was merchandise margin (3.8 total), 18% (1.8MM of the total) was occupancy, and 35% of teh decline was lower franchise revenue (2.8MM of total)

 

2. With respect to merchandise margin, was this degradation across the board with respect to product type?  Or perhaps a liquidation of softline inventory?

• Bruce Johnson Comment applies –outlet stores mix shift drove much of the margin decline – thus desire to expand sourcing efforts to increase

• Getting at Q4 outlet margins – mix shift away from form high margin “as is” returned merchandise and “discontinued products” (“as is” highest margin category for SHOS and “discontinued products” is also higher than other product margin)

i. As is product highest margin – resale of product already shipped (could also be dented in distribution)

ii. Sell product with are discontinued products at good (not as good) “DNO”

• Second reason margin declined was a more completive retail landscape for both hometown and outlet.  Other competitors (editor’s note: including big boxes such as HD & LOW) and manufactures “pushing margin down”

• Just over half of Outlet products are sourced from SHLD – so almost half can be affected with better product sourcing of “as is” and “discontinued products” (area of focus moving forward).

 

3. Is it reasonable to expect a normalized gross margin around 25% for SHOS?  If not, please comment on specific categories which may impact the overall margin.

• Management has been talking  about things to improve margins

• Such as (1) Move away from free delivery and (2) shifting into mattresses

• This quarter was mix shift and completive environment

• Not saying Q2 2013 margins are the “ new normal”

 

Working Capital

 

4. With sales increasing slightly, rationally accounts receivable and inventory are rising.  Yet accounts payable are declining.  Please provide commentary.

• “Is an odd quirk, you would have expected AP to rise”

• Both payables to Sears Holdings and other manufacturers declined

• Nothing structural changed – timing quirk

• Additional cash discounts with Sears & SHLD suppliers is reason SHLD and SHOS pay so fast

• SHOS pays SHLD in 10 days

 

5. Would it be reasonable to expect SHOS to normalize working capital and over time in line with comparable retailers? (i.e. days payable outstanding closer to ~45 days as compared to the ~4 to 6 days payable outstanding for SHOS)

• Under agreement they have, they essentially have SHLD add SHSO orders to manufacturers.

• Sears invoices SHOS once a week and SHOS pays within 10 days

• “as long as we continue under this structure we will have relatively short days outstanding”

• Advantage is not holding upstream inventory & in  purchasing logistics

• “we have option to utilize SHLD for a variety of services – we will evaluate in due course”

• “many pieces (of the SHLD agreement) that can be looked at different times

• Merchandise agreement and flow of inventory are hard to piece out (of SHLD) and not something they can do on ST basis

 

6. SHOS is approaching the anniversary of the one year Merchandising Agreement with Sears Holdings. Would it be reasonable to expect a long term deal along similar terms or might there be options for SHOS to improve working capital dynamics?

• Agreements are LT yet elements such that pricing is revisited each year.

• Look at SHLD disclosures – under agreements.  Pricing is refer to “services”

• Terms could be part of that structure

• Theoretically it could be changed yet challenging to do

 

Miscellaneous

 

7. Share Buybacks: Please comment on any plans to utilize a 105b1 plan to execute any stock purchases either for the company or executives.

• $25 MM authorized repurchase would be inclusive of any type of equity repurchase including a 105b1 plan

• Current 105b1 plan has nothing to do with execs

• If company wanted to have ability to purchase stock the Company could use the plan yet SHOS would not need to announce the 10b5

 

8. Is 3,000 stores still a reasonable target for long-term total units?

• Analysts & franchise site named the 3,000 – this is NOT a number endorsed by current SHOS CEO or CFO.  Legacy number from when SHLD owner SHOS

• Believe growth opportunities exist at all four segment of SHOS but haven’t publicly disclosed amounts, plans, or timing.

 

 

[muscleman]

Hey guys I had a call with the company this week regarding a few questions I had after browsing the 10Q.

 

Gross Margin

 

1. Please comment on what the reclassified outlet distribution costs consist of.  Why were they reclassified from SG&A to COGS this year? Was this related to the two additional franchised Sears Outlets?

• Historically a number of stores (in 10K) asterisk combined selling store and distribution center – but now that SHOS wants to franchise many of these stores they are putting the costs in COGS where they belong

•Cleaning things up to franchise.  By separating distribution costs from store cost the actual cost of sales is “lined up economically with GAAP”

• This is a “One time change” and all the locations which have this DC/store sharing have been reclassified. SHOS just decided not to restate previous financial statement for the reclassification.

 

Author’s note: So per the above, the gross margin miss was better than it appeared due to the reclass.  As such, Outlet margin was “only” down 17.0% instead of the 24.7% it appeared. 

 

So overall margin was down 6.9% instead of 9.0%.  Either way, with merchandise margin contributing nearly half of the GP decline it’s tough to make positive commentary.  To be specific, of the 6.9% decline from $156.4 to $148.4: 48% was merchandise margin (3.8 total), 18% (1.8MM of the total) was occupancy, and 35% of teh decline was lower franchise revenue (2.8MM of total)

 

2. With respect to merchandise margin, was this degradation across the board with respect to product type?  Or perhaps a liquidation of softline inventory?

• Bruce Johnson Comment applies –outlet stores mix shift drove much of the margin decline – thus desire to expand sourcing efforts to increase

• Getting at Q4 outlet margins – mix shift away from form high margin “as is” returned merchandise and “discontinued products” (“as is” highest margin category for SHOS and “discontinued products” is also higher than other product margin)

i. As is product highest margin – resale of product already shipped (could also be dented in distribution)

ii. Sell product with are discontinued products at good (not as good) “DNO”

• Second reason margin declined was a more completive retail landscape for both hometown and outlet.  Other competitors (editor’s note: including big boxes such as HD & LOW) and manufactures “pushing margin down”

• Just over half of Outlet products are sourced from SHLD – so almost half can be affected with better product sourcing of “as is” and “discontinued products” (area of focus moving forward).

 

3. Is it reasonable to expect a normalized gross margin around 25% for SHOS?  If not, please comment on specific categories which may impact the overall margin.

• Management has been talking  about things to improve margins

• Such as (1) Move away from free delivery and (2) shifting into mattresses

• This quarter was mix shift and completive environment

• Not saying Q2 2013 margins are the “ new normal”

 

Working Capital

 

4. With sales increasing slightly, rationally accounts receivable and inventory are rising.  Yet accounts payable are declining.  Please provide commentary.

• “Is an odd quirk, you would have expected AP to rise”

• Both payables to Sears Holdings and other manufacturers declined

• Nothing structural changed – timing quirk

• Additional cash discounts with Sears & SHLD suppliers is reason SHLD and SHOS pay so fast

• SHOS pays SHLD in 10 days

 

5. Would it be reasonable to expect SHOS to normalize working capital and over time in line with comparable retailers? (i.e. days payable outstanding closer to ~45 days as compared to the ~4 to 6 days payable outstanding for SHOS)

• Under agreement they have, they essentially have SHLD add SHSO orders to manufacturers.

• Sears invoices SHOS once a week and SHOS pays within 10 days

• “as long as we continue under this structure we will have relatively short days outstanding”

• Advantage is not holding upstream inventory & in  purchasing logistics

• “we have option to utilize SHLD for a variety of services – we will evaluate in due course”

• “many pieces (of the SHLD agreement) that can be looked at different times

• Merchandise agreement and flow of inventory are hard to piece out (of SHLD) and not something they can do on ST basis

 

6. SHOS is approaching the anniversary of the one year Merchandising Agreement with Sears Holdings. Would it be reasonable to expect a long term deal along similar terms or might there be options for SHOS to improve working capital dynamics?

• Agreements are LT yet elements such that pricing is revisited each year.

• Look at SHLD disclosures – under agreements.  Pricing is refer to “services”

• Terms could be part of that structure

• Theoretically it could be changed yet challenging to do

 

Miscellaneous

 

7. Share Buybacks: Please comment on any plans to utilize a 105b1 plan to execute any stock purchases either for the company or executives.

• $25 MM authorized repurchase would be inclusive of any type of equity repurchase including a 105b1 plan

• Current 105b1 plan has nothing to do with execs

• If company wanted to have ability to purchase stock the Company could use the plan yet SHOS would not need to announce the 10b5

 

8. Is 3,000 stores still a reasonable target for long-term total units?

• Analysts & franchise site named the 3,000 – this is NOT a number endorsed by current SHOS CEO or CFO.  Legacy number from when SHLD owner SHOS

• Believe growth opportunities exist at all four segment of SHOS but haven’t publicly disclosed amounts, plans, or timing.

 

Thank you GrizzlyRock. I tried to contact them and they told me to write an email. I asked some questions about SHOS and SHLD, and they never replied.

Do you know if SHOS leases the real estates from SHLD, or does it own the real estate when it was spun off?

[Luke 532]

Hypothetically take the mean of the Days Payable and its 60.2 Days.  If SHOS were to go from 7.1 Days to 60.2 Days accounts payable would go to $303.5 Million.  Compare that with the current A/P of 131.3 million and that means we'd have an extra $172.2 Million in cash.  Take that out of the enterprise value and it looks better with EV / EBITDA of 10X but still not that cheap.  And you need to remember that SHLD is one of their primary suppliers so you can't count on the same days payable as the peers.  However think about what this exercise looked like when the stock was $15 or even $30.

 

When you asked the question in the final sentence, on June 3rd 2013, the stock touched $57.  We're now at the sub-$30 level you were imagining.

 

Yeah from this point of view, since SHOS's supplier is SHLD, it is unlikely that the days payable will go from 7 days to 60 days.

If the stock price drops back to $30, this will be an interesting stock, right? :)

 

It's certainly interesting enough for me at current prices.  I initiated a position today in the $29.XX range.

[GrizzlyRock]

If the price is cheap at these levels depends on three main things

 

(1) sustainable gross margin rates

(2) unit growth / re-franchising opportunities

(3) if/when and to what extent working capital normalizes (highly unlikely to comp in line with other hardware / hardline retailers due to SHLD trade payable terms)

 

time will tell...

[BTShine]

Does anyone have thoughts on this $6.4 million of costs related to being a public company?  It is a quarterly expense, but seems really high to me.  Does anyone have insight?  I can't believe this would be recurring....but, have no proof of that.

 

 

[Luke 532]

Haven't been posting them as they have been numerous, but it seems like a few of these are opening every week: http://www.bellinghamherald.com/2013/11/05/3297122/sears-hometown-store-planning.html