Imperial Capital, a little known shop is out with a big negative call on Sears Holdings (NYSE:SHLD) initiating the retailer with an Underperform and $6 price target.
- they are also initiating coverage on SHLD’s notes.
Already Weak Financial Results Appear Overstated by Pension Funding Costs; Real Estate and Brand Franchise Value May Not Be Enough to Overcome Tired Retail Operations— Initiating Coverage with a HOLD Rating on the 6.625% Senior Secured Notes due 10/15/18 on Sufficient Tangible Asset Coverage, a SELL Rating on the Long-Dated Senior Notes, and an Underperform Rating on the Shares, with a $6 Price Target.
While the overriding valuation thesis on Sears, they believe, has been its real estate holdings and potentially undervalued leased locations, they think the company’s underfunded pension plan (including significant annual funding requirements) and recently rapidly deteriorating operating performance outweigh the ability to monetize those assets while continuing to operate the retail chains in their current form.
Comments on the common stock:
On an adjusted basis, we believe EBITDA should be viewed as materially lower, given significant, ongoing pension funding requirements. Sears’ EBITDA of $1.3bn in FY10 and $809mn for the LTM ended 10/29/11 does not consider cash pension and post-retirement funding costs of $316mn in FY10 and LTM of $386mn, we believe. We calculate that net adjusted EBITDA (adjusted for cash pension funding costs) was $1.017bn in FY10 and $423mn for LTM—for leverage of 8.2x through the 6.625s (compared to 4.3x before the adjustment) and 10.0x through the unsecured debt (versus 5.2x).
* Recent accelerating deterioration in financial performance is draining cash and will likely require more debt.
* Real estate assets and iconic brands (Craftsman, Kenmore, and DieHard) are not sufficient to overcome underperforming retail operations.
* Sears’ retail operating platforms have been hurt by underinvestment and poor execution while the competitive climate has intensified. Sears’ retail operations have continued to languish over the years— capital expenditures have been running at close to 1% (or less) of revenues compared to 2–3% of revenues for select comp companies such as Lowe’s, Home Depot, Target, and Wal-Mart. Furthermore, customers continue to find store-level staff unmotivated and poorly trained for the most part, according to our experience. In our opinion, customers may be further distanced from the brand due to store level staff not being adequately trained or motivated to provide a high level of service. Meanwhile, the competition continues to take market share.
* The midpoint share valuation in our sum-of-the-parts analysis is $6, thus providing the basis for our share price target. We are valuing Sears Holdings Corporation using a sum-of-the-parts analysis to delineate values for the stronger business segments, including Sears’ 80% stake in Orchard Supply Hardware Corporation (OSH) and catalog retailer Lands’ End. We also assume that the underperforming businesses have value to a strategic investor that is willing to acquire those businesses, invest in the store base and, successfully execute on a retailing strategy. Our midrange enterprise valuation is approximately $6.514bn, which is 11x our FY11 EBITDA estimate of $590.7, 32x our FY11 net adjusted EBITDA estimate of $203.7mn. After deducting $3.474bn of secured debt, $765.9mn of unsecured debt and the pension/post-retirement liability of $1.68bn, we estimate value to the equity of just $591.8mn, or $6 a share, down 91% from the current share price of $60.49. Accordingly, we are initiating coverage coverage with an Underperform rating on the common stock and with SELL ratings on the longer-dated unsecured bonds, which we think will likely trade down on further potential erosion in operating performance.
Notablecalls: Scatching note from Imperial Capital should send SHLD trading down in the n-t despite the already negative Street sentiment and 45% short interest. Note the $6 price target is a mid-point of targets. SHLD could have negative equity value, according to Imperial.
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I see it trading somewhere in the $50-55 range n-t.