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September 07, 2005

Sears Holdings Earnings Preview

Northlake clients remain long Sears Holding (SHLD) ahead of second quarter earnings due to be reported before the open tomorrow. The company is not expected to host a conference call but will release a 10Q and probably a note from Eddie Lampert along with the earnings. Current client positions in SHLD are on the small side as half of the original positions were sold in July when the stock was at $160. With the weak performance since then the holding is now below average and I decided to wait on the earnings report to decide if I want to rebuild to a full position.

Consensus estimates call for EPS of $1.36 on revenue of $13.7 billion. Investors will probably focus on same store sales trends, gross margins and operating margins....

....The second quarter marks the first of two very easy same store sales comparisons as 2Q/3Q04 both saw same store sales decline slightly over 7%. Consequently, investors will want to see a big improvement with analyst estimates ranging from -1% to 1%. Gross margins are supposed to be up slightly due to some initial benefits from the merger in terms of buying and product mix on the shelves. Operating margins should expand more robustly. First, last year had some one-time items that depressed the margin by 60 basis points. Second, this quarter should see the first significant benefits from the cost reductions on the SG&A line that are the key driver to the earnings story over the next two years. When the company reported 1Q05 investors were disappointed in the margins which caused the shares to fall about 8%.

Besides the financial statements, investors will also be hoping to hear news on the opening and performance of Sears Essential stores, possible uses of the company's cash and balance sheet to enhance shareholder value, and an update on asset sales. Each of these items has the potential to impact the stock price as much as the earnings report.

SHLD shares have been poor performers against a weak retail group since peaking at $163 on July 20th. The 18% decline in the shares compares to a loss of 7% for the Merrill Lynch Retail HOLDRs (RTH). Both securities have been down for all but a handful of days since the end of July.

Normally, I'd consider this a good setup for a long side trade as the pessimism on SHLD seems severe. However, I think SHLD is a tough stock to trade as the story is designed to develop over a multi-year time frame as shareholder value is realized through a combination of cost savings, improved same store sales, asset sales, and possibly acquisitions. Furthermore, the stock has gained analyst coverage since the 1Q05 report with at least four major firms now providing research. Lack of coverage was a positive in 1H05 but additional coverage now works as a negative since most analysts are bullish and the investment story is a work in progress.

A good quarter will certainly be well received as it will take the pressure off the asset/cash flow story which is longer term in nature. I don’t feel that I have an edge off which to trade the quarter so I am sitting tight and will do any trades, at potentially significantly higher or lower prices, after analyzing the results.

Posted by Steve Birenberg at September 7, 2005 11:52 AM in SHLD