Tuesday, January 15, 2008

So Far, It’s More Like a Shutout

We expect to be within our previously stated guidance of $0.99 to $1.03 for earnings per share from continuing operations for the fourth quarter of fiscal year 2008.

—Wal-Mart Stores, 1/10/08

As a result of the lower sales and gross margin rates, we currently expect that net income for the fourth quarter ending February 2, 2008 will be between $350 million and $470 million, or between $2.59 and $3.48 per fully diluted share. In the fourth quarter of the prior year, the Company reported net income of $820 million, or $5.33 per fully diluted share.

—Sears Holdings Corp, 1/14/08

In the back catalogue of NotMakingThisUp there is no lack of selection when it comes to reporting on Sears and the efforts of Eddie Lampert to turn around what many of the smartest retail analysts I’ve ever known have widely considered unturnaroundable, to coin a word—at least, without a lot of money and some great retail management.

It’s not that we consciously picked on Sears, or even K-Mart for that matter. It’s just that it’s so easy to walk into a store and judge with your own eyes whether Wall Street’s Finest are getting it right, or not.

The respective press releases from Sears and Wal-Mart in the last week, quoted above, seem to confirm that, at least so far, NotMakingThisUp has not been making up the difficulties of turning around not just one, but two gigantic retailers.

June 30, 2005

Wal-Mart 9, Sears Holdings Corp 2

Yogi Berra might have said “you can see a lot just by looking,” or he might not. But it’s still a wise notion.

Which is why yesterday I found myself in a newly re-merchandised K-Mart store—sorry, a “Big K”—a few towns away from home, just looking.

Visiting stores is the fun part of investing in retail stocks. Unlike a lot of businesses that do things nobody can possibly get a handle on even by visiting the field operations—oil companies, for example, or software companies—when you study retailers, you can actually see with your own eyes whether the company is doing what the management says they’re doing.

The trick, however, is to see a lot of stores, at different times of the day and in different parts of the country, if possible.

Stores can be as empty as an Art Garfunkel concert or packed like they’re giving away shares of Google, just depending on the time of day and the day of the week and the season of the year.

Also, talking to employees is not always the best way to find out what’s really going on, because store clerks don’t think in terms of year-over-year-change-in-comparable-store-sales the way Wall Street types do.

When you ask the kid behind the counter, “How’s business?” and he says “Really slow,” he’s talking about the previous half hour. And, since employee turnover at that level averages probably 50% a year, it's likely he's only worked there a few months anyway.

So you go to stores and look at what people are actually buying, and try to talk to the store manager or someone who runs a department to find out what’s selling and what’s not, and see if anyone in a position to know can tell you how business has been for that store in recent weeks. And you do it as often as you can.

All that said, it’s usually pretty easy to see when a retail concept really works—and when it doesn’t—without a whole lot of effort.

So, after watching from the sidelines while Eddie Lampert built his own version of Berkshire-Hathaway buying up the remnants of two once-great retail chains—Sears and K-Mart—and combining them into a single once-great retail chain, I was interested in seeing how the nearest "Big K" was faring.

This particular “Big K” is off Route One, in a C+ location next to an Ocean State Job Lot, a Dollar Tree and a Fashion Bug, and it certainly looks a lot better than it looked during the the K-Mart Chapter 11 when the vendors weren’t shipping: the shelves are full, the signs are cheery, the lighting is good and the floors are clean.

And that’s about it.

“Big K” had that curiously soul-less feel of a decent-looking place with no particular franchise, nothing driving people in and little to keep them there. One ancient clerk moved slowly around the racetrack, putting up signage from a shopping cart when he wasn’t stopping to chat with other clerks. A few customers lurked in the aisles, but the only crowd was at the service desk.

Registers open? Two.

I then drove a few miles down Route One to the nearest Wal-Mart, which is in an A+ location next to a supermarket and a Home Depot. It was a typical Wal-Mart, bustling even at 11:30 on a Wednesday morning. The demographics of the shoppers were probably thirty years younger than the “Big K,” with mothers dragging children through the apparel section, kids roaming the DVD aisles and men in the tool area. Overall, it had the energy of a store doing a lot of business.

Registers open? Nine.

Now, Eddie Lampert is smarter, and richer, than 99.9% of the money managers on the planet. He found value in AutoZone and Sears and K-Mart, and extracted billions. A couple of other big investments didn’t work out so well, but that’s still a remarkable batting average for anyone in any line of work—and right up there with his role model, Warren Buffett.

But people forget that the original Berkshire Hathaway—the New England textile company Buffett acquired and turned into the conglomerate we all know and admire—failed.

Even Warren Buffett couldn’t make a New England-based textile company successful in a world of cheap southern mills and, later, offshore producers; so he liquidated that business, put the money into insurance, and used the float from the insurance business to buy high-return businesses with “moats,” as he calls their competitive advantages.

I have no doubt Sears Holdings Corp will be an even more successful investment vehicle for Eddie Lampert than it already has been.

But in its base business, with Wal-Mart adding more sales every two years than the combined annual sales of Sears and K-Mart together, I also have no doubt that whatever Sears Holdings Corp is making money at twenty years from now, it will not be making money from its motley collection of stores without billions of dollars of newly invested capital.

Yes, I know the “story” of Sears Holdings—just shut down a few hundred more lousy locations, start selling Sears appliances in the K-Mart locations, and get store productivity up to the level of Target. Voila! The incremental EBITDA and earnings are mind-boggling.

But there are no moats around those Sears stores and K-Mart stores with their lousy merchandising and old clerks and the ratty fixtures and 1980’s-era technology—only streets leading to better-looking, better-run, lower-priced Wal-Marts and Targets and Costcos and Sam’s Clubs.

And to get the customers back will require more than bright signs and Kenmore dishwashers.From what I saw, the score right now stands at Wal-Mart 9, Sears Holdings Corp 2.

If Yogi were watching, he might just say “it’s deja-vu all over again.”

Jeff Matthews
I Am Not Making This Up

© 2008 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


Tahoe Kid said...

Could we possibly have too many retailers? Or perhaps, too much retail square footage? Or, God forbid, both? Or, and this is the nightmare for every retailer, not enough shoppers? Seems to me the demographics of the U.S. are becoming more dominated by older folks who don't shop as much as they used to.They have enough stuff. And let's not forget that pesky little thing called the internet.

Jeff Matthews said...

From an astute emailer:

You mention location quality a couple of times in this post, grading the Big K location vs. the Wal-Mart location. Perhaps that is the major obstacle to turning Big K around and why it may just not be possible. Wally World, Costco, Sam's Club and Target are all building brand new stores on sites that are prime locations at this moment. Big K is trying to turn the company around in legacy locations that were built decades ago. W, C, SC and T are building new where the customer are but Big K is sitting in old stores built where the customers used to be.

I think of a Sears that closed down here in Austin years back. It shared Hancock Center with a big grocery store, smack in the middle of the University Park and Hyde Park neighborhoods and very close to the University of Texas itself. It is on several major bus routes and has it's own bus stop in the middle of the parking lot. It is also on I-35, the main highway. Hyde and University Parks used to be bustling middle-class to upper-class family neighborhoods filled with students; families of university faculty, administration and staff of UT and Concordia University; and the professional and non-professional staffs of St. David's hospital and its associated medical buildings. 20 years ago, this was the perfect area for a Sears.

Now a hundred year-old house of less than 1000sf in this area runs no less than $300k, so it is purely upper class; it is one of the two most expensive areas in the county. They are interspersed with the low-maintenance, low-quality, low-rent apartments (complexes and converted houses) that still house students and creative types. The house-dwellers drive to big box stores now, as there are many within easy driving distance, or to the many local retailers that cater to Austin's large natural/organic/enviro crowd. The students and creative types have little need for a store like Sears and are also more likely patronize the enviro stores. The grocery store, an HEB, undergoes expansion and renovation every few years to keep up with the demand. It is such a huge store now that it offers many of the product categories that our parents would have gone to a Sears for 20 years ago. The Sears was still thriving when I moved to Austin to attend UT in 1991. It closed in the late 90s. Many stores have moved into Hancock Center, into structures newly built in its once vast parking lot, including quite a few eateries. But the Sears building stands empty.

Best regards,
Constance Reader

Phillip Charles said...

I just read the 2/08 Conde Nast article about said topic. And while reading how they have tried to implement every retail strategy in the book, my mind kept drifting to one question of almost offensive simplicity: I wander if they ever thought of, for starters, simply changing the name?

'Sears' drips with images of 1975 Christmas catalogs, 50lb sewing machines and rustic-yellow canister vacuum cleaners. And I'm sure that the local Greenwich High marketing class could author something with a little more panache than 'Big-K', as well...just a thought