At this point, it’s hard to see the bull case for Sears Holdings Corp (NASDAQ:SHLD) as anything but an asset play. There hasn’t been a successful bull case for Sears stock, to be sure.
Sears has declined about 95% from 2007 highs. But what possibility there is of any value in SHLD stock largely comes down to the company’s real estate, in particular.
If the company can stabilize the Sears and Kmart businesses — somehow — then it can sell or lease back those properties, pay off debt and hopefully have enough left for shareholders.
To be clear, I don’t believe in that bull case, and bankruptcy is a very real possibility here. The business isn’t stabilizing, for one. Same-store sales declined over 7% in fiscal 2016 (ending January 2017), including a 9%-plus drop at Sears. Comps fell nearly 12% in the company’s disappointing first quarter. As a result, the company is closing more stores, in an effort to shrink its footprint and cut expenses.
The weakness of the business aside, however, there’s another, less covered, problem for SHLD stock. The value of retail real estate is falling quickly. That erosion has collapsed a key pillar of the long-term plan to create some value for Sears stock holders. From here, it looks like the final nail in the Sears Holdings coffin.
Retail Real Estate Weakness and Sears Stock
The same weakness seen in stocks of retailers across the board has made it way to retail space owners. Major retail real estate investment trusts (REITs) have seen significant valuation declines over the past year:
- GGP Inc (NYSE:GGP), higher-end shopping malls, -15%
- Simon Property Group Inc (NYSE:SPG), higher-end shopping malls, -23%
- Washington Prime Group Inc (NYSE:WPG), Class B and C malls, -29%
- Kimco Realty Corp (NYSE:KIM), neighborhood and strip malls, -38%
- Seritage Growth Properties (NYSE:SRG), diversified retail, -18%
The last on the list, Seritage, of course is a major lessee to Sears, and owns 224 Kmart and Sears properties. And while its relative strength may seem like good news for the portfolio that Sears still owns, SRG has become one of the market’s most-shorted stocks, as a proxy for shorting SHLD.
And overall, there are two clear trends in the performance of retail REITs. One is that retail real estate valuations are coming down. With companies including Gap Inc (NYSE:GPS), Sears rival J C Penney Company Inc (NYSE:JCP) and Abercrombie & Fitch Co. (NYSE:ANF), among many others, closing stores, retail real estate looks dangerous. That brings down the value of the still-owned real estate that was supposed to at least help Sears pay off its growing debt and at most provide real upside for SHLD stock.
The second problem is that the worse the property, the worse the declines. SPG and GGP tend far more toward upmarket “Class A” malls than WPG. WPG at this point now trades at just five times funds from operations (FFO), against 15 to 16 times for SPG and GGP. Yet Sears has sold or mortgaged its best properties.
What’s left has lost a lot of value. That’s a huge problem for Sears stock.
Closing the Doors on Sears Stock
The loss of real estate value seems like a fatal blow for SHLD stock. There was a case not that long ago where it didn’t really matter whether the Sears and Kmart businesses turned around. There was enough in the real estate to create some value, no matter what happened with the businesses.
At this point, however, it’s increasingly difficult to see a way out for Sears. The business burned about $1.5 billion in cash flow last year — and first-quarter performance was worse than it was the year before.
$1 billion in cost cuts were supposed to help — but even with $700 million in annualized savings accomplished, Q1 adjusted earnings and ebitda still declined year-over-year. Sears Holdings certainly has underinvested in Sears and Kmart stores, and in a tough retail environment they seem to have little chance of being real competitors.
CEO Eddie Lampert’s focus on the “Shop Your Way” loyalty program seems increasingly misguided, and the Sears and Kmart brands have been damaged — possibly irreparably. In an environment where JCP stock hit a three-decade low and where even Macy’s Inc (NYSE:M) struggles to compete, there doesn’t seem to be room for Sears or Kmart.
That leaves the assets, but most of them are gone through Seritage, the sale of Craftsman, the spinoff of Lands’ End, Inc. (NASDAQ:LE), and other real estate transactions.
What’s left is largely Kenmore and real estate that becomes less valuable by the day. As long as that trend continues — and there’s no reason to think it won’t — SHLD stock will continue to decline as well. It seems increasingly likely that decline will end at zero.
As of this writing, Vince Martin has no positions in any securities mentioned.