Tag: SHLD

We are always hearing about the negative US Savings Rate and how we are “living on credit”. It is only a matter of time before our bubble bursts and we are plunged into recession / depression or what ever else negative “sion” they can come up with. Let’s just ignore the number you see. Why? The method used to arrive at number we always see, while accurate 50 years ago, in today’s investor economy gives us a false number. Here is how.

Today savings is calculated as:

Income – Federal taxes – Expenditures= Savings

sound easy enough correct? Wrong and here is why.

1- Excludes capital gains

Let’s say I bought 300 shares of Sears Holdings (SHLD) in 2004 for $23 a share spending $6,9000. Wanting to pay for my kids college, I sold them last month for $180 a share pocketing $54,000 or a profit of $47,100.

According to the current savings calculation, that $47,100 is not counted as income..

2- Includes all Federal Taxes

Now, Of that $47,100 I now have to pay 15% long term capitol gains taxes of $7,050. That tax bill is included in the “taxes paid” portion of the saving equation even though the income that generated it was not.

3- Includes the spending of the gain

The remaining $40,050 that is sent to the college, is now counted as an expendtiture in the calculation..

so for what I just illustrated, the income and expenditures and taxes all equal out to zero BUT, for the National Savings Rate, it looks like this:

Income = 0
Federal Taxes = $7050
Expenditures= $ $40,050

This gives me a NEGATIVE savings on this transaction on $41,000 when in reality, it should be zero.

Another factor? 401k’s

How many retired people are getting an income from a 401K? If you are that numbers is NOT being counted as income, BUT the things you buy with it are being counted as expenditures, giving you an artificial negative savings rate.

Own a home? Has it increased in value? The increase in that value is NOT counted as savings either. When you sell it and have a gain you then roll over into another house, you have the same mythical spending with no income from our stock transaction. The money you put down on the new house and the taxes you may pay on the sale of the old are counted as expenditures but the gain on the sale of the old house is not counted as income.

Perhaps this is then reason that even though we have a “negative savings rate” as a nation, our household wealth is at all time highs?

There was a blog post out there this past week that said Sears Holdings (SHLD) should spin off it’s Land’s End line in order to create value for shareholders. It was a well written and thought out piece and I could not disagree with it’s author more. I cannot find where I read it but if the author reads this and wants, they can drop me a line and I will link to it. Here are the reasons for my disagreement:

The future of Sears retail:
In February I wrote, “I am rapidly becoming convinced that the future of Sears Holdings retail clothing operations will be predominantly Land’s End merchandise.” This thought was further bolstered when in his annual shareholder letter, CEO Eddie Lampert said that the Land’s Ends division had a record year in 2006 for both sales and profits. If this was not enough to convince people, at the annual meeting last week, Lampert said that the Land’s end “store in a store” concept was being expanded from 100 to 200 locations in 2007. If you have not been to one of these yet, go (here me Maggie?). The layout is enticing, the merchandise is wonderful and the pricing is good. In short, there isn’t anything not to like and based on this years results, I am not the only one who thinks this way. As these locations expand, watch as the retail metrics for Sears improve at an increasing rate. There has been some concern out there that the stores would just cannibalize the online operations. Results to date have proved just the opposite. People seem to be more willing to buy online if they are able to return merchandise to a store for an exchange rather than going through the annoying mail return procedure.

Selling Land’s End now would actually destroy long term shareholder value. Each of these locations, as they open increases the value of the retail operations. It would no doubt give us a short term boost, but it would come at a far too heavy long term price.

Brand Value
Recently Lampert created $1.8 billion dollars essentially out of thin air. What he did was to create a bond out of the Craftsman, Kenmore and DieHard brands. He found a way to quantify the value of these brands. As Land’s End becomes more prevalent and profitable for him, he can do the same for it. I have come to realize that Lampert is smarter than most people out there and sees things that most do not. If you look at it, he has created billions of dollars in shareholder value from two names, Kmart and Sears, both of whom were left for dead by the investing world. Land’s End will eventually have a value to him as a brand that is far in excess of the simple annual sales and profits from the division. Rather than selling this increasingly valuable asset, I would love to see it’s expansion grow at a faster pace. Lampert, however, is a far more patient and wealthier person than I so I will defer to him on it’s pace (that and the fact he has yet to ask my advice). Now, how much value could it have? It is hard to tell since Sears does not breakout individual results in their 10K, making quantifying it guesswork. My opinion is that since Lampert has repeatedly given Land’s End the lions share of credit for margins improving from 24% in 2004, to 27% in 2005 to almost 29% in 2006, its value is substantial and will continue to increase as more locations open.

Future Investments :
Now that Lampert has said he will begin to “look for investments” for Sears Holdings, between the cash on he has on hand and the value of the bonds he created he is sitting on almost $6 billion and multiples of that in borrowing power. The guessing games will begin. If Lampert’s, recent activity within Sears is any indication of his plans, any acquisition will have “Brand Appeal”. What is Dr. Phil’s saying? “The most accurate predictor of future behavior is past behavior”. He is the first retailer out there to quantify the value of a brand name in addition to it’s immediate effect on the profit and loss column. Expect the acquisition(s) to be of strong, respected brand names as for Lampert, it provides him value few seem to be easily able to see..

Here are the week’s “Top 5 Favorite Stories” as voted on by members of the Value Investor’s News website. It’s owner George has been kind enough to let me post this and I am thinking it will become a weekly feature for me since I find much of what is posted there very valuable. So, if it is good for me, why not you? With that said, here they are, enjoy them this weekend

1- Author Says Work “Has Been Wonderful” Omaha.com
2- Google: Caveat Emptor– ValuePlays
3- Buffet Never Makes Bet With Sucker Odds– Financial Times
4- Sears Holdings To Spend Cash Hoard– ValuePlays
5- Notes From The Wesco Meeting– Gurufocus

I got a great email from a subscriber a few weeks ago. He asked me about the use of “stop-loss orders”. To paraphrase:

“Do you use stops to protect yourself from a drop in stock prices and protect profits? If you do, where do you set them 10%, 20%?”

Let go to the basics. What is a “stop-loss order”? In its simplest form, it is a standing sell order place for a security you own at a set price below its current price. The theory is that they enable you to avoid a “meltdown” in the stock and protects you from a lost, or if you have a profit in the stock, preserve it. We need to look closer at this strategy though to see if it really delivers.

Investing vs. Trading
First things first. I am a value investor, not a trader. I only buy stocks in stable, fiscally strong companies that have a history of success. I have no use for fad stocks or 90% of technology stocks (I adhere to Warren Buffets thought process, “how can I invest in something that two 18 year olds writing code in their parent’s garage can destroy”?). Because of that, I have no use for stops. The reason is simple. When I buy stock in a company, whether it be 100 or 10,000 shares, I do it with the thought in mind that I am now buying a part of, and becoming an owner in, the company. This is no different than were I to buy a Dairy Queen franchise for example. I only consider selling my shares if there is a fundamental negative change in the company’s prospects or share prices become irrationally overvalued. This causes my outlook and perspective to differ dramatically from the trader who buys shares in the morning with the thought in mind to get rid of them in the afternoon. I fully expect the prices of my shares to fluctuate in value throughout my ownership period which in most cases is several years. Because if this thought process, dips in the price of my shares are for me, great opportunities to purchase more shares at a now discounted price. I always find it funny that Wall St.is the only place in America where buyers get upset when the things they want to purchase go on sale. If you consider yourself a long term owner of a company, think of a drop in the price of the stock simply as a “sale” and not a loss of money.

The “Stop Effect”:
Let’s do a real life example to see how stops can negatively affect our long term results. Our investor owns shares in Archer Daniel’s Midland (ADM) and has a 10% trailing stop in the shares. This means that the stop “trails” the price of the shares up so that it automatically adjust up to preserve profits. Here is the chart:

To give the investor full credit let’s say he bought shares at their lowest point at $15 a share in August, 2004. He set a trailing stop at 10% and watched as shares slowly increased to $25 a share in mid February, 2005. In the third week of February, shares dropped from $25 to $21 a share for no reason. There was no earnings released, no warning, nothing. Now, because the investor had a 10% stop in place, his shares were sold at $22.50 (10% of $25 is $2.50 below the $25 price). He was right to have the stop in right because he saved himself the extra $1.50 a share they dropped, correct ? No, and here is why. Taxes. Since the investor owned his shares for less that a year he is not eligible for the long term holdings tax rate of 15%. He has to pay his effective rate and we will assume that to be 28% (most investors fall into this rate). His gains were $22.50 -$15= $7.50. He now must pay taxes on that $7.50 which equal $2.10. This reduces his gains to $5.40. Now, if we add his realized gain to his purchase price, he effectively sold his shares at $20.40 or a full $2.10 BELOW his stop price. To rub more salt in his wounds, AMD shares traded back up at $25 a share the next week, so he effectively lost $5 in potential gains.

Wait, there is more….

Our investor has learned from his mistake but still believes in “stops.” He rubbed his wounds and bought into ADM the following week but this time moved his stop to 20%. This way he will be saved from “disaster” but not hurt by normal price fluctuations. At the end of March 2005 ADM announces earnings and they fall 9%. The stock sells off from $25 to $17 over the next few weeks. Now, the earning miss was just due to short term commodity price issues and not long term problems with the company or its businesses. In fact, cash flow increased, debt decreased and the company reiterated the results were short term in nature. Our investor though, because he had a 20% stop, sold his shares at $20 (20% of $25 is $5) avoiding the extra $3 a share loss as the share sunk to $17. Smart? Not so much….

Let’s look closer. In the first transaction he ended up with a profit of $5.40 a share and after the second one, a $5 loss, his profit was reduce to a total of 40 cents. Now, if he had never had a stop placed on the shares, he would be at this point sitting on a $2 profit ($15 purchase price- $17 current price). Our investor is undoubtedly frustrated with ADM and like most investors gives up on it and tries another stock. In doing this he then ends up missing the greatest run in the history of the stock to the $39 a share it sits at today.

Without the “stops“, this frustration would not have been present and he most likely would have still be in ADM and wondering what to do with the over 200% profit he is now sitting on.

Who was our “investor” in ADM? None other than yours truly. I was lucky enough to learn from my mistake(s), purchase more shares at the $17 level and have held on for the very profitable ride since then. I have no stops in place for ADM currently (nor do I in any of my investments) because the stock is a long term pick based on two things, food and fuel and until the world need neither, I will be a shareholder.

Lessoned Learned: Sears Holdings:

I bought shares in Sears Holding (SHLD) in December 2005 for $120 a share. I bought them because of Edward Lampert and his ability to make is investors money and having been to Sears and seen the changes there (the Land’s End “store in a store” concept is a sure winner), believed in his direction for the retailer. Another fact that did not hurt was his hedge fund, ESL Investments, sports a 28% annual return for investors. Remembering my ADM experience I did not place a “stop” order on the shares. They rose to their peak of $169 in early June 2006 and then plunged 20% over the next 7 weeks to $134 a share at the end of July. Had I placed another 20% “stop” on the shares, I would have sold them for a profit of $14 a share ($10.08 after taxes) or 8.4%. I also would have missed out on the immediate reversal of the shares as they then climbed to $180 by Halloween.

There was no reason to sell the shares in July. Eddie Lampert did not loose his ability to make money and Sears Holdings did not suffer a deterioration of the metrics he uses to measure its success. Do you know what the Summer 2006 prices were? A “Sears Sales Event”. I did take my other advice and bought more shares while they were “on sale” and at their current level of $180 a share I am sitting on a very nice 9 month return of 30%.

If you are an investor buying quality companies for the log haul, it is my opinion that “stops” will do you more harm than good in most cases. If you are a gambler just trading stock symbols with no real idea of how the underlying company operates, placing a stop on those trades may save you from the inevitable terrible trade you will make.

Another blowout quarter for RadioShack (RSH) and it’s Lampert University grad CEO Julian Day. Much has been written that past few weeks about The Shack in anticipation of its result and the sentiment was for of the end of the ride for shares. I will not point out those who wrote these articles but suffice it to say, wrong again folks. Results:

• Income from operations, $8.4 million ($0.06share) last year to $42.5 million ($0.31/share) this year, significantly ahead of analyst forecasts, as gross margins improved.
  Continue reading “Don’t People Get Tired Of Doubting "Lampert U" Grads?”

Eddie Lampert, Chairman of Sears Holdings has created $1.8 billion worth of securities based on the brand names Kenmore, Craftsman, and DieHard. What that means is he essentially transferred ownership of the brands to another entity, which it then pays for the right to use the brands. The deal, carried off last May, was the biggest “securitization” of intellectual property in history, according to Eric Hedman, an analyst at Standard & Poor’s. The story hasn’t gotten out until now because the bonds haven’t actually changed hands, Sears is holding them in its Bermuda-based insurance subsidiary and because Sears has never disclosed them, nor has it had to do so. That would change if Sears were to decide to sell them to outside investors and collect the cash.

How does It work?
Sears has disclosed that it has created a “separate, wholly owned, bankruptcy-remote subsidiary”. This is essentially a company within a company. It is called KCD IP (for Kenmore Craftsman DieHard intellectual property) and it has issued $1.8 billion worth of bonds backed by the intellectual property of Sears’ three biggest brands, according to filings with the Patent & Trademark Office.

Sears has in effect now created licensing income from it’s most known brands. First it transferred ownership of the brand names into KCD. Now, KCD charges Sears royalty fees to license those brands and uses the royalties to pay the interest on the bonds. It has sold the bonds to the insurance subsidiary, where, like any other security on an insurer’s books, it serves as protection against future loss. The insurer, meanwhile, protects Sears from financial trouble and because it’s a subsidiary of Sears, it does so at a lower cost than they could get from an outside party. Essentially, the deal at its current level allows SHLD to save money on insurance.

The question you are most likely asking is: Who is making money off the transaction? The answer? As it is set up, nobody. The payments net out to zero because Sears owns every piece.

Why Do It Then?
It seems like a whole lot of work to do for no profit. Why do it and how then can Sears turn these bonds into money?

1- Sell the bonds to outsiders. Then, Sears would be holding up to $1.8 billion in cash, and investors would be holding the bonds.

2- License the brands: Many people (me included) feel there is a huge revenue stream for Sears in the value of these brands. Allowing outside manufacturers to make products and use the Craftsman, Kenmore and Diehard brand names in return for royalty payments is an easy way to increase profits without any additional expense. These payments would be virtually 100% profit for Sears. More importantly, by licensing these brands they would be expanding the availability of them. I feel that especially with the Craftsman tool line, this could really have a compounding effect. Tool buyers are a brand conscious lot. If their favorite brand came out with a Craftsman line, given Craftsman’s reputation for quality, it would sell.

3- Swap bonds for debt. Lampert acquired K Mart through its debt. These new “brand” bonds allow him a vehicle to do a similar deal. How? Lampert could swap these bonds or a portion of them for the debt of another company. One morning shareholders of BJ’s could wake up and find that Sears Holdings owns all their debt. The beauty of this scenario is that it would require none of the cash Sears has in the bank ($4 billion) to be used. Having these bonds as leverage also allows for the possibility of a much larger acquisition.

4- Insurance. In the past I have speculated on the possibility of Sears getting into the insurance business. Now we have an insurance subsidiary of Sears sitting there holding $1.8 billion in bonds that could be used for an acquisition. As I stated in the past, I think there are few acquisitions that would make the stock price of SHLD explode to the upside than the purchasing of an insurer.

The creation of these bonds opens up a plethora of situations in which they can be used to add value to Sears Holdings for shareholders.

At the end of the day, what Lampert will do with this is a mystery. It is great fun for us to speculate though. If we do it enough, eventually one of us are going to be correct. What I do know is that given his past track record, we shareholders will benefit greatly.

Things are getting exciting here.