Sears Holding Group (SHLD)

The number one reason to own Sears for the long haul is one: Eddie Lampert. This honest, Buffett-esque hedge fund manager understands his sole reason for being in business is to create shareholder wealth. Just read this sample from his strikingly honest letter in the 2006 annual report:

We allocate capital to initiatives that we believe will provide the greatest returns and create the most value for our shareholders. 2006 was no different, as we deployed $2.14 billion of capital to repurchase shares, invest in our business, and reduce debt, as follows:

• $816 million used for share repurchases (we repurchased over 6 million shares in the year at an average price of about $133 per share);
• $474 million used for capital expenditure reinvestments in our businesses;
• $318 million contributed to fund our legacy pension obligations;
• $282 million used to purchase an additional interest in Sears Canada. Our ownership level is now 70%, up from 54% last year; and
• $250 million used for net debt reductions as our domestic debt balance declined to $3.0 billion (or $2.3 billion excluding capital lease obligations).

As an investor, the most important information to glean from this segment is the average repurchase price ($133). This should tell they lay person something crucial; Sears management things that its stock is a deal, undervalued, at or below $133.

Before delving deeper into Sears operations, we need to return to Eddie Lampert. Using his uniquely long-term and patient hedge fund, he has took control of Sears Roebuck and K-Mart before pulling of an efficient, effective merger in 2004. They control 42.5% of SHLD shares.


The business is divided into three main segments; K-Mart, Sears Domestic, Sears Canada.

K-Mart Segment
As of February 3, 2007, Holdings operated a total of 1,388 K-Mart stores within the US. During fiscal 2005, the Company began selling proprietary Sears brand products (Kenmore, Craftsman, DieHard, and services) within certain K-Mart stores. Approximately 100 Kmart stores were selling this assortment of Sears brand products. During the fall of fiscal 2006, the Company added Craftsman tool assortments into Kmart locations nationwide. In addition, as of February 3, 2007, approximately 180 Kmart stores were also selling an assortment of major home appliances, including Kenmore.

Sears Domestic
Domestic consists of 935 broadline stores of which 861 are full-line stores in 50 states. Store inventory includes home appliances, consumer electronics, tools, fitness and lawn and garden equipment, certain automotive services and products, such as tires and batteries, home fashion products, as well as apparel, footwear and accessories for the whole family.

Domestic also includes 1,095 Specialty Stores, including: 817 Independently owned dealer stores, 111 Sears Hardware Stores and 85 Orchard Supply Hardware Stores (Small Hardware stores), 16 The Great Indoors Stores, 47 Outlet Stores, and Commercial Sales Division.

Domestic continues its diverse operations with 'Direct to Consumer' division including Land's End brand, via internet, catalog, and overstock retail sales (15 storefronts, also in Sears store sales).

Homes services offers over 10,000 service technicians making over 13 million service calls annually, this business delivers a range of retail-related residential and commercial services in 50 states.

Sears Canada
Owning 70% of this subsidiary, Sears Canada operated a total of 123 full-line stores, 48 furniture and appliance stores, 158 dealer stores operated under independent local ownership, 5 appliances and mattresses stores, 28 Corbeil stores, 11 outlet stores, 50 floor covering stores, approx. 1,900 catalog pick-up locations, 100 travel offices, and internet based Sears store.

Finances and Figures

-In the first quarter of 2007, SHLD repurchased 97,343 shares for an average price of $165.95.
-Over the past three years book value per share has grown 64%
$ 82.65 -2006
$ 72.67 -2005
$ 50.39-2004 (PreMerger)
-Gross margin improvements offset small decline in same store sales.
-Investment income $254 million up over $127 million the year before. Representing 18% of income.
-$74 million via Total Return Swaps*
-Debt reduced by $0.4 billion
-$2.0 billion common share repurchase program ($0.6 billion complete)
- S&P Debt Rating +BB
-ROE - 12.2%

Recommendation
With a precived weak US market, the price of SHLD should continue to drift down. Currently trading around $126, the stock sells well below prices that the Company repurchases. The real test is the fourth quarter (Holiday season). Last 4Q created EPS of $5.33; with this season expected to be disappointing, expect SHLD to remain cheap through years end. This stock is tied to North American consumers in regards to its cash flow. TLTI's recommendation is to slowly add this stock to your portfolio over time. Find SHLD on the bad days and add to your stake. With Lampert at the helm, hold this stock for as long as he does. Forever.

*Total Return Swaps which are derivative instruments that synthetically replicate the
economic return characteristics of one or more underlying marketable equity securities. In exchange for receivingthe return tied to the position underlying a total return swap, the Company pays a floating rate of interest tied to LIBOR on the notional amount of the contract.