Don't Give Me Those Old-Time Retailers

 | Dec 28, 2011 | 10:00 AM EST
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It's a little difficult to get back into the swing of things following a great Christmas with the family, but research never stops. The quest for value never takes a vacation.

My stock screens tend to be filled with companies trading below book value. This is standard for a value investor but it has drawbacks, and it's important to recognize that a deep discount to book value is not necessarily a ticket to riches.

Take Sears Holdings (SHLD), for instance. A few years ago this was a darling of the value crowd due to the prowess of Chairman Eddie Lampert, but also due to the perceived value of the company's real estate -- and Sears has a vast real estate portfolio, which, at fiscal year-end 2011, includes 834 Kmart, Sears and Sears Canada locations. Following Tuesday's 27% drubbing, shares now trade at just 0.47x book value per share. If you back out intangibles, Sears trades for 1.1x tangible book value per share.

I was not a buyer of Sears then, when it traded as high as $190, and I'm not a buyer of Sears now at $33. As much as I tout companies that own their real estate, there are cases where the story does not make sense. What bothers me is that Sears, which was considered a shopping mall anchor store (and a place where my family often shopped) in my youth, is no longer a dominant retailer, and efforts to regain that status have largely failed. Perhaps the Land's End acquisition was a positive, but it's simply not enough.

Declining operating performance calls into question the perceived value of the company's real estate. It's one thing when you are a thriving business and own the land and buildings; it's quite another when you are struggling. Unfortunately, as value investors, we sometimes fall into a dreaded value trap. A company's assets might look great on paper, but without the ability to convert those assets into cash, and without the ability to generate a bottom line, they might not have the value you've perceived. Distressed asset sales can quickly render even the best analysis as useless.

The latest old-style retailer touted by the value crowd is J.C. Penney Co. (JCP). Some very smart people have taken positions due to the prowess of new CEO Ron Johnson, who has had a very successful career and is considered by many to be a retail mastermind. Penney's also has a formidable real estate portfolio that excites investors. While the company does not have Sears' baggage (such as K-mart), I couldn't help being reminded of the Sears story.

Maybe Ron Johnson takes the company to the next level, and maybe JCP is a homerun for investors. I just can't get the perception out of my head that JCP is an old-style retailer -- a place we shopped with our parents 30 years ago but have not visited since.

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