Long Sears Hometown and Outlet Stores


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Long Sears Hometown and Outlet Stores

  1. 1. 1 Long Sears Hometown and Outlet Stores (SHOS) March 30th 2014 Tianyou Gu Sagehen Capital Management
  2. 2. 2 Sears Hometown & Outlet Stores Overview  SHOS, traded at Nasdaq, $23.6, Market Cap $537 Million  Spinoff from Sears Holdings Corporation in late 2012  Sells hardware, home appliances, lawn and garden equipment – 4th largest retailer of home appliances, 1,200 stores across 50 US states – 2013 Revenue of $2.45 Billion
  3. 3. 3 Why Buy SHOS?  Cheap and Undercovered Spinoff – No analyst coverage – Valuation in the Range of $32 - $48 – Has declined 60% from its high – Insiders purchased at much higher prices  Core Strengths and Superior Business Model – Keeps the core strength of hardware and appliance brands from Sears – Expands in a “capital-light” franchise operating model  Favorable Tailwinds – Benefactor of Sears Holdings store closings – US housing recovery, online platform expansion  Shareholder Friendly – Created specifically to unlock value from Sears Holdings by hedge fund manager Eddie Lampert, who’s currently the chairman – Share buybacks
  4. 4. 4 Superior Operating Model  Dealer/Franchise Model – SHOS collects a royalty for the use of the Sears trademarks meanwhile offloading the capital-intensive parts of managing a retail operation to its dealers/ franchisees – The inventory is provided by Sears Holdings and SHOS receives a percentage of profit from sold goods  Benefits from Franchise Model – Capital light; high margin royalty income – Effective than centralized model – Asymmetric risk/reward  Profitable and growing online business platforms  Favorable Alliance with Sears Holdings – Rapidly expanding membership rewards program operated by Sears Holdings Corporation – SHOP YOUR WAY™ – Delivery, installation and product service capabilities through alliance with Sears Holdings
  5. 5. 5 Competition  Competitors: Home Depot, Lowe’s, BestBuy, Kohl’s, Walmart, Amazon  Safe from competitive threats due to different product and geographic focus – Locate stores in more rural settings and smaller markets, generally in areas that are too small to attract the Home Depot and Lowe’s – SHOS is isolated from competition from Amazon and Wal-Mart given the types of items it sells: consumer durables, tools and lawn & garden equipment
  6. 6. 6 Valuation  $23 is at bottom of 52-Week Range (between $20.5 and $57.5)  Comparable Implies $32 – $42 – Using Implied EV/EBITDA of 7.5x – 8.5x and P/E of 15x – 18x  DCF Implies $36 - $48, under Conservative Assumptions – 25% - 28% gross margins (LTM 24.5%) and 4 - 5% net profit margins (LTM 3.2%) – These net profit margins are less than the 4 and 6% generated by Lowe's and Home Depot, respectively – Growth rate 2.5% (historically 1.5%) in next 5 years, then 1.5% terminal growth rate – Stable capital structure  Insider’s Buying at $30 – 40 in Past Twelve Months EV/Revenues EV/EBITDA EV/EBIT Forward P/E Growth Gross Margin EBITDA Margin Net Income Margin SHOS 0.2x 7.0x 7.9x 13.0x 3.20% 25.35% 2.82% 1.47% BestBuy 0.2x 4.0x 6.5x 16.8x 1.20% 22.90% 3.25% 1.30% Lowe's 1.1x 10.6x 10.2x 15.40x 2.50% 32.44% 10.69% 4.28% Home Depot 1.6x 11.4x 13.6x 21.20x 5.40% 32.70% 13.90% 6.80% Valuation Multiples Operating Ratios
  7. 7. 7 Tailwinds/Catalysts  Benefactor of Sears Holdings store closings – As Sears executes its transition plan (closing department stores and switching channels to online and SHOS), more retail flow will be directed to SHOS – This creates significant, long-term revenue growth opportunity  Improving 2014 financials – Fiscal 2013 results were significantly below expectation, caused by unusually severe winter weather in many of trade areas and disappointing holiday sales of important Kenmore appliances and Craftsman tools – Positions favorably for 2014 as SHOS opened 30 stores last year, with half of those openings occurring in January – Double-digit year-on-year growth in both online and multichannel sales – Product mix shifts towards high-margin tools from home electronics  Real estate market recovery  Rural market expansion, Online platform growth  Share buyback plans
  8. 8. 8 Risks  The U.S. real estate market reverses its upward trend – Clean balance sheet protects the company from severe hits  Continued lack of coverage from the investment industry; stays undervalued in the near term – Tailwinds – Already at bottom of trading range, very little downside risk  New franchises may expand at a slower speed  Bottom line: majority shareholder is a hedge fund manager (Eddie Lambert), who will maximize shareholder value
  9. 9. 9 Recommendation  Buy 1000 Shares of SHOS worth $2,3600  Adjust position based on earnings calls (Q1, 2014 comes out in three months)