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August 21, 2006

Sears Results Better Than Stock Price

Sears Holdings (SHLD) earnings reports was largely in line. However, the stock traded sharply lower, giving up most of its gains so far in August. The decline can be attributed primarily to two things. First, SHLD is owned by a lot of aggressive investors and they wanted another big positive surprise like the company delivered the last two quarters. Second, as described further below, the press release indicates that investment of the company’s substantial cash balance in new ventures might be likely. The uncertainty related to what these investments might be concerns some people. I think that the retailing part of the story including the massive cash generation is on track and I like the idea of Eddie Lampert, one of the most successful investors in the last decade, investing that cash on behalf of shareholders. SHLD remains a unique investment and small positions fit nicely in the portfolios of most investors.

EPS of $1.74 exceeded consensus of $1.67 but given the lack of estimates and any guidance form the company, I’d call the number within the margin of error. Revenues of $12.8 billion were above expectations. Gross margins expanded by 120 basis points and EBITDA margins grew by 110 basis points. Same store sales fell by 3.8%, an improvement over the 1Q decline of 4.8%. Sears had a same store sales decline of 6.3%, while Kmart had a decline of 0.6%. Sears results improved from a 1Q decline of 8.4% and a 4Q decline of 12%. Kmart has been at plus or minus 1% for the last several quarters. Inventories rose slightly, which might be a concern on declining sales, but management explicitly noted that it was planned increase due to earlier deliveries of fall merchandise and a desire to add to merchandise displays in certain categories....

The shares were very strong in the few days leading up to the earnings report so it is hard to read too much into the initial sell-off following the results. If I had to guess why the shares might be trading lower on a generally good report it would be the inclusion in the press release of a section titled “Investment of Available Capital.” This section did not appear in the 1Q report. Management notes that the company has plenty of excess capital and indicates that it could be used to invest in the stores, buyback stock, invest in other public companies, or “fund investments that it believes offer the Company attractive return opportunities, whether or not related to its ongoing business activities.”

Combined with a low level of share repurchase activity in the quarter, less than 1 million shares, for just $91 million, at an average price of $137, this new section might have some investors concerned that Eddie Lampert may have something new up his sleeve. This is pure speculation on my part and I may be way overanalyzing and looking for conclusions where none exist.

I plan to hold all my SHLD, which I own across the Northlake client base. Regardless of the reaction to the earnings, this report largely leaves the long-term story intact. Little has changed based on the new information so my opinion remains unchanged and bullish.

The shares were very strong in the few days leading up to the earnings report so it is hard to read too much into the initial sell-off following the results. If I had to guess why the shares might be trading lower on a generally good report it would be the inclusion in the press release of a section titled “Investment of Available Capital.” This section did not appear in the 1Q report. Management notes that the company has plenty of excess capital and indicates that it could be used to invest in the stores, buyback stock, invest in other public companies, or “fund investments that it believes offer the Company attractive return opportunities, whether or not related to its ongoing business activities.”

Combined with a low level of share repurchase activity in the quarter, less than 1 million shares, for just $91 million, at an average price of $137, this new section might have some investors concerned that Eddie Lampert may have something new up his sleeve. This is pure speculation on my part and I may be way overanalyzing and looking for conclusions where none exist.

I plan to hold all my SHLD, which I own across the Northlake client base. Regardless of the reaction to the earnings, this report largely leaves the long-term story intact. Little has changed based on the new information so my opinion remains unchanged and bullish.

Posted by Steve Birenberg at August 21, 2006 03:01 PM in SHLD