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November 15, 2006

Sears Holdings 3Q06 Earnings Preview

Sears Holdings (SHLD) reports before the open tomorrow. In fact, it will probably have reported by the time you read this. The company doesn’t host a conference call. All we get is the financials and a press release with some commentary. The limited information flow, the stocks high price and high volatility, and the ongoing controversy over the company's same store sales performance, will likely produce some fireworks in the stock. According to a note I read yesterday on theflyonthewall.com, SHLD options imply a potential move over $9. Big move for sure, but keep in mind that is just 5%.

After the company reported its last quarter, the shares fell sharply from $160 a few days before the report to $135 a week or two after the report. The stock has since recovered and is trading just under its 52 week high. The recovery is due to some signs that same store sales are trending OK (which means better than last quarter's -3.8%), less fears about Lampert making a big new acquisition, renewed share buyback activity in 3Q which was not evident in the 2Q report, and expansion of the share buyback by $500 million....

There are six earnings estimates on First Call averaging 98 cents. The estimates vary widely with a low estimate of 83 cents and a high estimate of $1.05. The axe is SHLD, Credit Suisse analyst Gary Balter, is at 98 cents. There are only two revenue estimates, $11.67 billion and $11.94 billion. Reuters is reporting a consensus revenue estimate of $11.82 billion.

Last quarter, same stores sales fell 3.8% with Sears down 6.3% and Kmart down 0.6%. Sears same store sales, while deeply negative have improved for two consecutive quarters following a double digit decline last holiday season. Kmart has had several consecutive quarters of flat to -1% same store sales. While I still believe that SHLD has another year at least where same store sales should not matter to the stock price, I think investors will be looking for a number less negative than last quarter. I have seen a couple of reports suggesting that SHLD's comps might show improvement based on sales performance at Danaher and Martha Stewart, two important suppliers to SHLD.

The real story at SHLD, for the time being, is margins. Last quarter, gross margins rose 120 basis points and EBITDA margins rose 100 basis points. I think further margin expansion is required for the stock to continue to work higher. Look for performance at least as good as last quarter in the 3Q report. Some improvement in SG&A leverage would nice as well.

Also, look for improvement in inventory management. That is part of the reason for the expectation of continuing increases in gross margins. Last quarter, inventories were a little higher than expected so improvement this quarter would be a positive and might be necessary to keep the stock on an uptrend.

Finally, an update on share repurchase activity to see the pace since the authorization was increased in mid-September. However, the press release maybe silent on activity since the quarter ended.

SHLD shares are close to Gary Balter's long standing $180 target, a target I have adopted in deference to the analyst who clearly knows this story the best. I've been willing to hold the stock with limited upside because I like the idea of letting Eddie Lampert manage part of my clients money. After all, he might be better at money management than me!

Posted by Steve Birenberg at November 15, 2006 03:52 PM in SHLD