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May 19, 2006
"Sears Profit, Shares Surge; Doubts Linger"
The headline of this post is what appeared in the Chicago Tribune this morning. The article goes on to quote three retailing experts, each of whom takes a negative view of the company. As I have noted previously, Sears Holding (SHLD) is being run for the shareholders. This means Sears the stock is a far different animal from Sears the stores. I view the skepticism as very good news for shareholders of SHLD and think the shares can move well above old highs in the low $160's as trends that emerged in the first quarter seem highly likely to be repeated over the balance of 2006.
The quarter was exceptionally strong relative to analyst estimates. EPS came in at $1.14 vs. consensus of 64 cents and a high estimate of 82 cents. EBITDA, the key metric for analyzing SHLD at this point in time was over $600 million, at least $150 million better than expected. Most of the strength in profits came from margins. Gross margin rose 140 basis points and SG&A as a % of sales fell by 114 basis points. These factors caused the operating margin to be almost 3% against expectations of a little over 1%.
Sales were down year over by 5% and comp store sales fell by 5% as well. Sears comp store sales fell by 8.4% and Kmart had a comp of -0.2%. The Sears number was a bit better than expected and a big improvement over the last two quarters where comps fell 10-12%. Kmart comps have now been plus or minus 1% for the past four quarters.
Following the quarter, analysts are raising their estimates sharply. Consensus EPS for 2006 were $7.72 prior to the report. I read through four analyst reviews this morning each of which has an estimate of $8.00 or higher, including one that is at $9.00.
The continuing decline in sales is what drives the negative view of the retailing experts....
Investors have been conditioned to look at same store sales as the primary measure of a retailer's health. Eddie Lampert has a different view. He is targeting profitability, not sales growth. In fact, given the last two quarter's results one thing is incredibly clear: for years Sears was selling lots of stuff for a horrible margin. Why would they do that? Probably because they were being slaves to comp store sales. However, as a shareholder, as an owner of these stores, what I want is higher profits and a return of the that cash to my checkbook. This is the strategy that Eddie Lampert is following.
I can sell SHLD anytime, so all I really care about is whether the stock price can move higher. With $3.3 billion in cash (about $20 per share), additional cost cutting and margin expansion opportunities, and stabilizing sales trends, I think shareholders are in a very strong position at SHLD. For the next year or two, these are the dominant trends --- and these trends are likely to be good for shareholders. We'll let the experts worry about whether Sears and Kmart have a long-term future as retailers. In the meantime, we will enjoy higher stock prices for SHLD.