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Sears Hometown: The Better Spinoff

Ever since Eddie Lampert and his ESL Investments sank its teeth into Sears Holdings (SHLD) back in 2008, investors have been wondering about the nature of the endgame for the American retail icon. But one thing we do know is that it has involved — and probably will continue to involve — selling off assets.

Two of the more notable efforts in this direction involved the spinoffs of Orchard Supply Hardware (OSH) in December 2011, then Sears Hometown and Outlet Stores (SHOS) in October 2012.

Sears itself has managed to hang on after completing the breakups. Despite some pretty  poor financial performances, its stock is down only 10% over the past year, which might be better than one would expect out of the struggling retailer. But what about its offspring?

Well, the California-based Orchard Supply never really had a chance after being orphaned. Three consecutive years of flatlining annual revenues, same-store sales in perpetual decline, and a fourth quarter that saw a net loss soar to $33.6 million from $7.2 million in a year … it all ended in a bankruptcy declaration earlier this week, with Lowe’s (LOW) trying to pick up some of its assets.

Sears Hometown, however, isn’t such a bad situation.

SHOS is a thriving entity selling home appliances, tools and lawn & garden equipment through its 1,200-plus stores across all 50 states. Those home appliances and tools include well-known Sears brands Kenmore and Craftsman, and it also carries Diehard battery products for automobiles

Operationally speaking, while OHS owned all its stores, SHOS runs both company-owned and franchised stores. The mix is skewed heavily (95%) toward franchised, with a stated goal to increase that percentage while also expanding. According to the company’s 10K filing:

We believe we can reduce our capital expenditures, grow our store base in a capital efficient manner, and leverage the local knowledge and expertise of franchisees by moving more of our Home Appliance Showrooms, Hardware Stores and Outlet Stores to the franchise model.”

That model does help limit capex outlays, which in both fiscal 2011 and 2012 came in at under $10 million. SHOS provides the franchisees inventory on a consignment basis, and helps with branding and marketing to the stores; the franchisee is responsible for startup costs, lease payments and other operating costs.

SHOS lives in an ecosystem that includes both Lowe’s and Home Depot (HD), so it has adopted a location model that keeps it under the radar: Most Sears Hometown and Hardware stores are located in rural markets, outside the reach of the big-box giants. Competition trends toward local hardware dealers, and SHOS benefits from its pricing relationship with Sears to offer lower prices.

Meanwhile, its Sears Appliance Showroom stores are located in well-populated urban settings, offering a more intimate feel for buyers. It still leverages the Sears name, of course, and draws those who don’t want to walk through aisles of clothes or the perfume gauntlet just to get to the washing machines.

It’s a tad early to call SHOS a total success, but the signs are there: For its first full year of operation (ending Jan. 31), FY ’12 revenue grew 5% compared to 2011 to $2.453 billion, with bottom line growth of nearly 81% at $60 billion compared to $33 billion.

First-quarter 2013 results, however, were disappointing: Revenues declined 3% year-over-year to $601 million, while net income dropped 27% to $24.7 million. SHOS blamed it on a slow start for the lawn & garden segment, owing to a long winter in many parts of the country.

But what separates SHOS from its cousin OSH is financial strength: A free cashflow of $80 million along with a similar amount of cash and equivalents in fiscal 2012 will go a long way with little debt and capex needs. Just in case, SHOS has nearly $200 million available under a revolving line of credit to fund any short-term needs.

So while it’s not totally smooth sailing for Sears Home and Outlet Stores, it’s got the financial stability, product strength, business structure and geographic reach to make a strong go of it over the long-term.

While I wouldn’t necessarily walk away from an investment in either market giants Lowe’s or Home Depot in favor of SHOS, I believe it’s a nice small-ball way to play the progressing rebound in the U.S. housing market.

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2013/06/sears-hometown-the-spinoff-winner-shld-shos-lwo-hd-osh/.

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