As I’ve told you time and time again, the retail industry is in crisis. Buffeted by structural changes such as the explosion of ecommerce, weak consumers and an increasingly selective consumer base, there’s been an epidemic of mall-based retailer bankruptcies lately (Sports Authority, RadioShack, Aeropostale, American Apparel, Pacific Sunwear…) and it’s only going to get worse. I’ve recommended some profit opportunities here.
Your personal Black Friday shopping spree won’t change that reality in the least, though I hope you score some good deals.
And while you’re in the mood for a bargain, you should probably think about a short position in this retail stock.
It may not even last until Christmas.
But I think this is one gift that will keep right on giving.
Nobody Can Clean Up Sears’ Colossal Mess Anymore
No short portfolio is complete without Sears Holdings Corp (NASDAQ: SHLD), one of the biggest disasters in recent years. 2016 could well be the company’s final Christmas season because at the rate it is going, by this time next year the stock could be trading at zero. I’ve been recommending Sears as a short since Chairman Eddie Lampert was having it buy back stock at $190 a share a few years ago, one of the grossest misuses of corporate funds in business history. And now the stock has lost 90% of its value.
Like the mainstream press that just humiliated itself in the presidential election, the financial press set a new standard in stupidity and sycophancy in its treatment of Sears’ majority shareholder, hedge fund manager Eddie Lampert. A decade ago, Mr. Lampert was heralded as a young Warren Buffett. Since then, he presided over the collapse of not one but two of the greatest names in American retailing, Sears and K-Mart, while managing to enrich himself and impoverish the investors in his hedge fund and Sears shareholders. It is one thing to define investment genius down, but Mr. Lampert’s performance is nothing short of a disgrace. Not only did this investment collapse, but it swallowed Mr. Lampert’s hedge fund along with it. As I’ve said many times, beware of investing with celebrity managers. Once they get famous, their best days are behind them.
But Lampert is not alone in this investment. Another so-called investment genius, Bruce Berkowitz, manager of the once-successful and now woefully underperforming Fairholme Fund (FAIRX), is up to his eyeballs in this disaster. Mr. Berkowitz has been pushing the narrative that investors will be bailed out by Sears’ “hidden” real estate value. Think again! Sears has been selling off its prime real estate assets for years, but the proceeds of these sales are being consumed by billions of dollars of operating losses in its retailing operations. As desperately as Lampert is trying to shrink the retail operations, he can’t do so quickly enough to stem the bleeding that is sucking up the value of the real estate. The so-called “smart money” (and believe me, anyone who calls himself “smart” is compensating for something) thinks that the real estate value will outrun the losses, but a hard look at Sears’ numbers and the collapse of Sears’s stock price tells a different story.
To see the folly of relying on the value of Sears’ real estate to save the company, take a look at the spin-off of 235 Sears and K-Mart stores into a REIT called Seritage Growth Properties (SGI) (an oxymoron if there ever was one) in July 2015. Wall Street hyperventilated over this deal, but it was really hyperventilating over the fees it generated. How a REIT whose main tenant is going bankrupt can be a good investment is a mystery to me. The deal generated $2.7 billion of proceeds for the company but added roughly $170 million of annual lease payments to the company’s expenses (which increase by 2% annually thereafter). Of the $2.7 billion of proceeds (you have to read the fine print in the company’s annual report to find this information because the press releases try to make it sound like the company actually received $2.7 billion of cash – which it did not come close to doing), $745 million came from Lampert, $297 came from Berkowitz’s Fairholme Fund, and $1.2 billion was borrowed. In other words, only $458 million of new equity capital was raised from non-insiders! And the $1.5 billion of equity won’t last long for a company burning $1 billion of cash every year – two-thirds of it has already been burned up and thrown down the rat shoot. The problem with this transaction is that it only took about a year for the company to eat up the cash it generated from this deal and is now left with the added lease expense. Plus the company no longer has those stores to sell. The situation was spelled out pretty plainly when the company reported a paltry $218 million of cash on its balance sheet at the end of 2016 even after completing the Seritage and other financing transactions a mere five months earlier. Sears stock has lost roughly 50% of its value since the Seritage deal as investors wake up to the fact that, to quote Gertrude Stein, “there is no there there” – if there ever was.
Sears Is In A Hole – and Just Keeps Right On Digging
As of the end of August 2016, the company’s debt has risen to $5 billion and the company had to enter an agreement with the Pension Benefit Guaranty Corporation, the government agency that is left holding the bag when companies go bust, to protect beneficiaries of its $2 billion pension fund. After years of losses and financial engineering that have destroyed the company, the government doesn’t want to be left to clean up Mr. Lampert’s mess.
It is also running low on cash again. Sears had only $238 million in cash at the end of August and was again promising more financing transactions to keep itself afloat. But it is increasingly relying on borrowing money from Lampert and Berkowitz and its own pension plan since outsiders want no part of this mess. The company remains cash-starved and in constant need of raising more money to fund its incessant operating losses. I expect to hear that vendors and factors will be reluctant to extend credit for holiday sales as we did last year. Nobody wants to get caught holding the bag.
Lampert has presided over some of the biggest losses in American business history. Such is the stuff genius is not made of. Sears lost -$1.0 billion, -$2.6 billion and -$1.0 billion in 2015, 2014 and 2013, respectively. Cash flow from operations in those years was -$2.2 billion in 2015, -$1.4 billion in 2014 and -$1.1 billion in 2013. For the six months ended July 32, 2016, the company lost another -$866 million and had cash flow of -$640 million. Revenues and same store sales collapsed sequentially during all of these periods with some minor variations. In case anybody is paying attention, losses are increasing despite Lampert’s best efforts (which are obviously not very good) to stop the bleeding. This is the type of “hedge fund genius” that has unfortunately spread to many of Mr. Lampert’s peers including Bill Ackman, John Paulson and others.
The company has also been hurt by serial management failures. Like the destruction wrought by Bill Ackman at J.C. Penney & Co. (JCP ) before he had the decency to leave the scene of his crime, Mr. Lampert has left a trail of losses and destruction behind him at Sears. The stores are the equivalent of a bombed-out row house in one of America’s inner cities (and many of them actually sit in such neighborhoods). People only shop at Sears if they have to, not because they want to. Have you heard anybody talk about wanting to shop at Sears? That’s like saying they want to go to the dentist, or they want to have a colonoscopy! Sears is a shopper’s last choice. And that’s why it’s heading for the bone yard.
Even worse, Mr. Lampert has proven to be impossible to work for and has run through so many executives whose judgment he second guessed that the company is one of the worst places to work in America. You can put what Mr. Lampert knows about retailing in a thimble. Yet he still thinks he is smarter than everyone else. The billions of dollars of losses and plunge in the stock price suggest that he is not.
It’s time for investors to start coming to terms with the fact that investors like Lampert and Berkowitz made their money in the pre-crisis world. And that world – and the rules of the game in that world – no longer apply. Sears is an artifact of retail business that is dead and gone. Sears stores mark the landscape like gravestones on a Civil War battlefield. Sears’ business was decimated by the structural changes rocking the retail world from ecommerce and there is no way it can survive.
My paying Zenith Trading Circle subscribers got my top trade recommendation last week, and it would not be fair to them to release it outside the circle, but you may want to consider buying 2017 OTM puts on SHLD, and doing it before Christmas, because this stock is not long for this world.