SHOS - Sears Hometown and Outlet Store

[focusinvestor]

Either way, we are getting a trough multiple of trough operating margins and EBITDA... I think a lot of things have to go wrong for us to lose money at these prices.

[Evolveus]

Nice to see to see SHOS highlighted in the recent MOI Deep Value Issue. I guess "nice to see it in deep value territory" depends on what your cost basis is  :)

[jeffmori7]

Nice to see to see SHOS highlighted in the recent MOI Deep Value Issue. I guess "nice to see it in deep value territory" depends on what your cost basis is  :)

 

Is this available somewhere? Or can you summarize what is written in there? Thanks.

[peridotcapital]

An excerpt from something I recently read.  Any thoughts on this?

While this thought experiment is not an exercise in precision, one would assume that this tripling in franchise units should result in at least a commensurate move in total revenues (in truth we think odds are much likelier to be higher given better efficiency/throughput of new units vs. the older Hometown units but we digress). In that case, a tripling of last year’s revenues of $2.5B over the next 10 years would leave us with ~$7.5B come 2023. If we assume modest additional gross margin expansion of another ~3% between now and then, SHOS would generate approximately $2.25B in total gross profit. With SGA likely to remain flattish around ~$504m, then 2023 operating income would be a whopping ~$1.75B.

 

At 12x ~$1.75B op income, SHOS’ equity value would be ~$21b. Assuming the same 23m shares outstanding, that is over $900 per share for a 20x return. Better yet, if Lampert manages to retire half the float along the way, then you can double that number.  One could do worse than make almost 40x their money over the next decade, no?

 

What’s crazy about the above is that none of the inputs feel unreasonable assuming they can deliver in terms of unit growth. Indeed, the above assumptions seem down right conservative. Revenues could just as well be higher, as could gross margins. SG&A could conceivably be half the present run rate or less. Either way, looking out over the long run, an exponential compounding of per share value seems almost assured.

 

Lots of optimistic / erroneous projections in there:

 

1) A tripling of the store base in 10 years? That's 250 new stores a year for a decade. They are on pace for 30 new units in 2014. A 12% CAGR for new units is very unrealistic. A 5% CAGR (double the current rate of openings) would get you 60% more stores in 10 years, not 200% more.

 

2) Gross margin expansion in the current retail environment (getting more and more promotional and unlikely to subside) is not an easy task. Getting to the high 20's does not seem to be conservative. Assuming flat GM as a base case would be a far more conservative estimate.

 

3) Flat SG&A when the store base goes from ~1250 to ~3750 makes no sense. Commissions paid to franchisees are counted in SG&A costs. As the store base grows, commissions will rise in concert.

 

4) 12x operating income is an awfully high multiple. Not impossible, but at the high end of fair. Certainly not conservative.

 

5) Going from 1250 units to 3750 units is more likely to trigger some cannibalization of sales than increasing revenue per store over time.

 

FD: Long SHOS, just more realistic than that.

[Luke 532]

National Association for Business Resources Names Sears Hometown and Outlet Stores, Inc. as One of Chicago's 101 Best and Brightest Companies to Work For http://online.wsj.com/article/PR-CO-20140819-910057.html

 

 

[AAOI]

An excerpt from something I recently read.  Any thoughts on this?

While this thought experiment is not an exercise in precision, one would assume that this tripling in franchise units should result in at least a commensurate move in total revenues (in truth we think odds are much likelier to be higher given better efficiency/throughput of new units vs. the older Hometown units but we digress). In that case, a tripling of last year’s revenues of $2.5B over the next 10 years would leave us with ~$7.5B come 2023. If we assume modest additional gross margin expansion of another ~3% between now and then, SHOS would generate approximately $2.25B in total gross profit. With SGA likely to remain flattish around ~$504m, then 2023 operating income would be a whopping ~$1.75B.

 

At 12x ~$1.75B op income, SHOS’ equity value would be ~$21b. Assuming the same 23m shares outstanding, that is over $900 per share for a 20x return. Better yet, if Lampert manages to retire half the float along the way, then you can double that number.  One could do worse than make almost 40x their money over the next decade, no?

 

What’s crazy about the above is that none of the inputs feel unreasonable assuming they can deliver in terms of unit growth. Indeed, the above assumptions seem down right conservative. Revenues could just as well be higher, as could gross margins. SG&A could conceivably be half the present run rate or less. Either way, looking out over the long run, an exponential compounding of per share value seems almost assured.

 

Lots of optimistic / erroneous projections in there:

 

1) A tripling of the store base in 10 years? That's 250 new stores a year for a decade. They are on pace for 30 new units in 2014. A 12% CAGR for new units is very unrealistic. A 5% CAGR (double the current rate of openings) would get you 60% more stores in 10 years, not 200% more.

 

2) Gross margin expansion in the current retail environment (getting more and more promotional and unlikely to subside) is not an easy task. Getting to the high 20's does not seem to be conservative. Assuming flat GM as a base case would be a far more conservative estimate.

 

3) Flat SG&A when the store base goes from ~1250 to ~3750 makes no sense. Commissions paid to franchisees are counted in SG&A costs. As the store base grows, commissions will rise in concert.

 

4) 12x operating income is an awfully high multiple. Not impossible, but at the high end of fair. Certainly not conservative.

 

5) Going from 1250 units to 3750 units is more likely to trigger some cannibalization of sales than increasing revenue per store over time.

 

FD: Long SHOS, just more realistic than that.

 

Peridotcapital,

 

Figured I'd chime in as I wrote the above. To be clear, the exercise above was a "blue sky" scenario that was written last minute before I published it to illustrate the potential for exponential compounding in per share value over time given all the various levers at Lampert's disposal - so apologies for the sloppy errors re the SGA (can't believe that one got past my edits) - my intention was simply to lay out a thought experiment towards that end. 

 

At any rate, on unit growth, agreed 3000 is aggressive but I didn't pull it out of thin air. For what its worth, the only reason I used the number in the first place was because of comments made by management prior to the SHOS spin. That said, Merkhet is correct to point out that management backed off that number, and again, agree that it's aggressive. Then again, 3000 units across all segments at maturity doesn't strike me as pie in the sky looking out 15 years nor do I think growth of that nature would necessarily cannabilize sales. Reasonable people can obviously disagree here.

 

On gross margins, agree that it will likely be 2-3 years before gm's normalize around those levels but I continue to believe 27.5% is probable given the growth at outlets, the ongoing mix shift and other factors. Time will tell of course.

 

Regardless, SHOS is fantastically cheap at these levels. Just figured I'd clarify.

 

Best,

 

AAOI

 

   

[peridotcapital]

An excerpt from something I recently read.  Any thoughts on this?

While this thought experiment is not an exercise in precision, one would assume that this tripling in franchise units should result in at least a commensurate move in total revenues (in truth we think odds are much likelier to be higher given better efficiency/throughput of new units vs. the older Hometown units but we digress). In that case, a tripling of last year’s revenues of $2.5B over the next 10 years would leave us with ~$7.5B come 2023. If we assume modest additional gross margin expansion of another ~3% between now and then, SHOS would generate approximately $2.25B in total gross profit. With SGA likely to remain flattish around ~$504m, then 2023 operating income would be a whopping ~$1.75B.

 

At 12x ~$1.75B op income, SHOS’ equity value would be ~$21b. Assuming the same 23m shares outstanding, that is over $900 per share for a 20x return. Better yet, if Lampert manages to retire half the float along the way, then you can double that number.  One could do worse than make almost 40x their money over the next decade, no?

 

What’s crazy about the above is that none of the inputs feel unreasonable assuming they can deliver in terms of unit growth. Indeed, the above assumptions seem down right conservative. Revenues could just as well be higher, as could gross margins. SG&A could conceivably be half the present run rate or less. Either way, looking out over the long run, an exponential compounding of per share value seems almost assured.

 

Lots of optimistic / erroneous projections in there:

 

1) A tripling of the store base in 10 years? That's 250 new stores a year for a decade. They are on pace for 30 new units in 2014. A 12% CAGR for new units is very unrealistic. A 5% CAGR (double the current rate of openings) would get you 60% more stores in 10 years, not 200% more.

 

2) Gross margin expansion in the current retail environment (getting more and more promotional and unlikely to subside) is not an easy task. Getting to the high 20's does not seem to be conservative. Assuming flat GM as a base case would be a far more conservative estimate.

 

3) Flat SG&A when the store base goes from ~1250 to ~3750 makes no sense. Commissions paid to franchisees are counted in SG&A costs. As the store base grows, commissions will rise in concert.

 

4) 12x operating income is an awfully high multiple. Not impossible, but at the high end of fair. Certainly not conservative.

 

5) Going from 1250 units to 3750 units is more likely to trigger some cannibalization of sales than increasing revenue per store over time.

 

FD: Long SHOS, just more realistic than that.

 

Peridotcapital,

 

Figured I'd chime in as I wrote the above. To be clear, the exercise above was a "blue sky" scenario that was written last minute before I published it to illustrate the potential for exponential compounding in per share value over time given all the various levers at Lampert's disposal - so apologies for the sloppy errors re the SGA (can't believe that one got past my edits) - my intention was simply to lay out a thought experiment towards that end. 

 

At any rate, on unit growth, agreed 3000 is aggressive but I didn't pull it out of thin air. For what its worth, the only reason I used the number in the first place was because of comments made by management prior to the SHOS spin. That said, Merkhet is correct to point out that management backed off that number, and again, agree that it's aggressive. Then again, 3000 units across all segments at maturity doesn't strike me as pie in the sky looking out 15 years nor do I think growth of that nature would necessarily cannabilize sales. Reasonable people can obviously disagree here.

 

On gross margins, agree that it will likely be 2-3 years before gm's normalize around those levels but I continue to believe 27.5% is probable given the growth at outlets, the ongoing mix shift and other factors. Time will tell of course.

 

Regardless, SHOS is fantastically cheap at these levels. Just figured I'd clarify.

 

Best,

 

AAOI

 

 

 

Appreciate the clarification. I agree it's cheap (I've been a buyer between 19 and 22 this year), but the industry dynamics are going to be a headwind for them in my view, so it's no slam dunk. That said, the risk/reward looks quite favorable. I'm not a huge fan of moving the Outlet business from owned to franchised, but hopefully they'll figure out how to generate consistent and significant cash flow from their unique business model (it's not nearly as attractive as restaurant franchising, although many bulls wrongly assert that it is).

[abominablenoman]

Looking at the the slideshow with the Sears Holdings Conference Call today on slide 41, it indicates that with regards to comparable store sales for Q2 2014, Sears Domestic was up 0.2% with primary drivers being increased sales in appliances and mattresses, which more than offset decreased sales in Electronics, Lawn & Garden, and Auto.  This may be a leading indicator that SHOS results that come out next month should at least be comparable to last year's results.

[jeffmori7]

SHOS Q2 release: http://www.shos.com/Files/SHO_2014_Q2_Earnings_Release.pdf

 

SSS -6.3%...the stock also!

[txlaw]

Very ugly.  SHOS seems to be a casualty of ESL's overall SHLD strategy.

[jeffmori7]

Yup, it was supposed t be a asset-light channel to sales KCD, with smaller format store opening everywhere. Sales are down, just 23 opening so far this years for both Hometown and outlet concepts.

 

Is the Sears name permanently impaired, thus affecting SHOS and KCD?

[txlaw]

Yup, it was supposed t be a asset-light channel to sales KCD, with smaller format store opening everywhere. Sales are down, just 23 opening so far this years for both Hometown and outlet concepts.

 

Is the Sears name permanently impaired, thus affecting SHOS and KCD?

 

I think so, unfortunately.  Both "Sears" and KCD are being affected by ESL's strategy at SHLD. 

 

Of course, ineptitude may also be a major cause of the decline in adjusted SSS.

[lathinker]

I have followed SHOS for some time but could never convince myself to buy as I thought I did not understand it well enough, in particular to assign any value to its growth prospects. Given the recent drop in share price, I took another look.

 

At this level however (Stock at 16,06, market cap at 365mm USD), I wonder if there is much downside. Valuing current assets at 1x, I see NCAV of 285mm USD plus they have property and equipment at 52mm on their books. So to me, this looks very close to liquidation value at the moment, unless there is an overstatement in inventory.

Also, profits have not been great, but the company has not burned any cash in the past nor do their debt levels life-threatening, so in fact the odds of the company liquidating itself look tiny. The main risk if you are buying at this level appears that the company starts burning cash which also appears rather unlikely.

 

On the flipside, I acknowledge that retail is one of the hardest businesses to be in, I would also not suggest that SHOS had any significant moat. However, there is a scenario that their business picks up somewhat following Home Appliance or improved efficiencies in Outlet (as mentioned in their 2Q press release).

 

To me, this looks attractive, mostly because of price. Would be interested to learn what risks you guys see from this level.

 

Disclosure: No position

[Kash50]

At the current price ($16), SHOS is definitely worth a look. Especially given that the last leg down ($17.50 to $16s) is very much correlated to the latest SHLD move down post the $400mm loan announcement. I suppose that is because the market has linked deteriorating financial performance at SHLD to deteriorating financial performance at SHOS. At <1x tangible book, the market is saying that SHOS's existing concepts are destroying value. But looking into the details, I’m not so sure. I also do believe that the Sears Outlet and Sears Hometown formats do have their own moats to a certain degree.

 

Here’s what we know:

1. Sears Outlet, NOT Hometown is where most of the deterioration in SHOS's LTM financials are . If you look at Outlet EBITDA ex-franchise fees, LTM = $5mm vs. an average EBITDA of $45mm+ in the years 2009, 2010, 2011, and 2012. So while Hometown does fluctuate from year-to-year, my focal point has been to understand what is going on at Sears Outlet.

 

2. Sears Outlet's gross margin dropped from 28-30% historically to 20-22% over the last 5 quarters.

 

3. In the latest quarter, while SHLD had positive comps in appliances (65% of SHOS sales), while SHOS comps were down 6% (mainly driven by Outlet comps down 9% , where 80% of sales are appliances). So the assumption that SHLD and SHOS' fundamentals move together is not the case.

 

4. In 2013, Sears Outlet sourced 59% of its merchandise from non-sears holding sources (up from 53% in 2012). I’m sure 2014 will be even higher. So therefore, the going forward value of Sears Outlet has less to do with SHLD/KCD and more to do with understanding why Outlet SSS are performing terribly and whether these reasons are temporary or structural.

 

My research has led me to 3 important points RE sears outlet ---

 

1. Availability of "as-is" inventory and Outlet Gross Margins ---  In 2013, Outlet gross margins dropped from 28-30% historically to 20-22% (there is a one-time PF adjustment you need to make in the historical margins to account for distribution costs, but that still results in a 25-26% gross margin). SHOS indicated for the reason for this compression in margin was due to a lack of "available out-of-box as-is inventory". This forced SHOS to sell "in-box" inventory at a much lower margin. So why did this happened? In 2013, as Outlet opened 17 stores and SHLD closed 200 stores, there was a crunch of available inventory coming from SHLD. And even though SHOS had been diversifying away from SHLD, it had not done it fast enough to meet the growth in Outlet.

 

So the company put in efforts to extends its reverse supply-chain sourcing network to get more appliance from other big-box retailers. As of the 1Q SHOS press release, the CEO said that this effort was largely complete and we should see margins tick up --- in 2Q, they did just that going up 150 bps in an environment where almost every other retailer saw margin compression as other retailers were heavily discounting to drive traffic. So I believe you should continue to see the Outlet segment gross margins rebound over the next 12-18 months.

 

2. Long term, I believe outlet does have a competitive moat as an appliance retailer because it can procure its inventory at the lowest cost. Outlet has a low-cost competitive advantage because it serves liquidation channel of out-of-box inventory for other retailers (think of the TJX/Ross Store model). Outlet has unique logistical/reconditioning/QA capabilities and unmatched scale and geographic coverage for processing scratch and dent appliances. It is also easier for a big-box retailer to send their scratch/dent merchandise over to a liquidator rather than try to invest the resources to recondition it themselves and then the sales effort to sell it next to a new "in-box" item. Outlet is the only national liquidation channel for appliances. The only others choices for retailers are local mom & poop or to do it themselves.

 

3. this past quarter, outlet comps were 9% due to "the narrower price difference between Outlet 'as-is' appliances and new, in-box appliances adversely affected sales in our Outlet segment." If you talk to management, what they will tell you is the highly promotional environment for appliances (especially from Sears Holdings) led to a a "narrowing" between as-is scratch/dent appliances and new in-box appliances. Specifically, you saw Sears Holding offer free home-delivery, big discounts, and aggressive financing offers. That is why SHLD appliance comp'd up but gross margins took a huge hit (down to 21% from 25%). Therefore, the traditional outlet customers decided to "trade-up" and buy new appliances given the difference was much smaller.

 

Outlet could have used the same promotional tactics as Sears Holding in order to drive volumes, but decided not to be as aggressive and only offered 1 of 3 not 3 of 3 promotions. You can see this is true given the margin acceleration in the business. So the key here is understand whether or not the big-box retailers (esp. SHLD) will keep a highly promotional environment on their appliances. As of now, I have not heard of any changes in the retail environment since 2Q releases, but it does seem like generally the retail environment/sentiment is (on the margin) better than 1Q/2Q.

 

One quick note on Hometown and its competitive advantage --- Many people focus on Home Appliance Showroom, but the Outlet and legacy Hometown concepts are 90% of SHOS's business and where the current value lies. The moat at Hometown is a geographic moat --- namely, they pop up in towns/cities where there are few alternatives (and a HD/LOW/big box retailer would never go given the small population sizes). Hometown is actually a pretty stable business and --- across its entire network --- should do fine.

 

[Studesy]

Is SHOS being irrationally pulled down with all the negative SHLD news...or does the recent news actually affect SHOS as well?  It is trading below tangible book value now.  At what point is the margin of safety sufficient here? Any thoughts.  Thx

[peter1234]

Is SHOS being irrationally pulled down with all the negative SHLD news...or does the recent news actually affect SHOS as well?  It is trading below tangible book value now.  At what point is the margin of safety sufficient here? Any thoughts.  Thx

 

There are probably members that know more.

 

I think Sears owns the inventory of SHOS. So yes, if vendors have issues with delivering to Sears it would impact SHOS.

[txlaw]

Over 80% of SHOS inventory is directly purchased from SHLD.  So, yeah, inventory issues at SHLD affect SHOS, especially Hometown.  And SHOS continues to heavily rely on SHLD for its ops. 

 

Also, if Sears name is "mud," that is not good for SHOS.  Especially if they plan on expanding based on a franchise/dealer model.

[eskebranded]

I am somewhat familiar with this name, and at around $21 /shr(earlier in the year) I once thought it was a great investment because I believed the firm would benefit disproportionately from an acceleration in Sears store closing. Fortunately, I passed on the stock given the competitive pressures which I anticipated to come. 

 

Look, the business makes sense, and the focus on the rural markets would imply a narrow moat at best. But the negative outweighs the positives, by a wide margin. The appliance industry is feeling the pressures from several irrational players, most notably anyone of the large consumer electronics retailers (Best Buy and HHGreg). As we all know, BBY and HGG have slightly shifted their strategies to gain share in the , what was once a growing market, appliance market as the consumer electronic business took a nose dive due to a weak refresh cycle (Don’t forget about Lowes and Home Depot which hold a sizable share). Boosting free deliveries and jaw dropping price cuts they grew this business nicely. SHOS has never participated in free delivery promotions, however last qtr they announced their new promotion which, you guessed it right, includes free deliveries.

 

What also scared me a bit was that SHOS suffered from an inventory shortage from its wildly profitable Outlet concepts. I think this segment accounted for roughly 70% of the businesses operating profit and only 25% of sales. I'm not sure what percent of the open box and slightly damaged products come from Sears, but my guess is there a bit more diversifies than their Hometown stores. Competition in this space is starting to heat up as well with BestBuy starting to sell more open box items both online in their brick and mortar locations. I personally don’t see this subsiding anytime soon.

 

As a franchise model, I was instantly attracted to the firm asset light business model. I also liked the businesses new CFO (from BestBuy), solid balance sheet (net debt ~$55mm) and low float. However, I was feeling discomfort from the firms multiple store banners, why do you need 5?, the lack of transparency with the investment community (no earnings call), and the dependency on Eddie and Sears (though this could be argued to be their edge –buying power).

I’m on the sidelines for now, would love to see some stability and better strategy for inventory procurement for their Outlet stores. If that happens, I see huge upside, due to the firms earning power potential. 

Over 80% of SHOS inventory is directly purchased from SHLD.  So, yeah, inventory issues at SHLD affect SHOS, especially Hometown.  And SHOS continues to heavily rely on SHLD for its ops. 

 

Also, if Sears name is "mud," that is not good for SHOS.  Especially if they plan on expanding based on a franchise/dealer model.

[merkhet]

Looks like Francis Chou initiated a position in SHOS.

 

http://www.dataroma.com/m/holdings.php?m=ca

[bci23]

He's had a position for some time but it does look like he has increased it recently.

[merkhet]

He's had a position for some time but it does look like he has increased it recently.

 

I believe you're thinking about Sears Holdings. This seems new.

[OracleofCarolina]

Not new..he had it as of 6/30

 

http://www.chouamerica.com/Opportunity.html

 

[merkhet]

Ah, my mistake. I wonder why it didn't show in Dataroma before...

[jeffmori7]

SHOS lost another 10% today. I will look again into it after the results. It could get interesting.

[eskebranded]

SHOS lost another 10% today. I will look again into it after the results. It could get interesting.

 

Are you concerned that this is just a tracking stock for Sears Holding?