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8 retail stocks worth more dead than alive
Despite the recent sub-par profits posted by many department store and supermarket chains, opportunities for investors remain thanks to unrealized value in their vast real estate holdings.
By Michael Brush
Most of us armchair economists think we are pretty clever as we furtively assess the tone of business while were out shopping at stores like Sears Roebuck (S, news, msgs), Bloomingdales, Kmart (KMRT, news, msgs), Dillards (DDS, news, msgs) or Toys R Us (TOY, news, msgs).
Wed actually be better off logging on to city archives and sizing up the value of their real estate.
Profit growth at many a big retail chain has been troubled for years, putting a lid on their stocks. But underneath, their real estate holdings have multiplied in value. Now the buildings, leases and land alone are often worth more than the value investors put on the actual business.
For a striking example, look no further than Kmart. In the past few quarters, the discount retailer has sold more than 70 stores to other chains like Sears and Wal-Mart Stores (WMT, news, msgs), for an average of about $12.4 million each, or about $130 per square foot. Multiply this by Kmarts 1,400-strong store base and then divide by the number of shares, and the real estate alone is worth $153 per share, says Louis Taylor of Deutsche Bank Securities.
Thats amazing, considering the stock recently traded for $80 a share. On paper, at least, Kmart shareholders could gain 86% if Kmart simply locked the doors and sold its stores. (How could Kmart leave its former stockholders holding the bag in its bankruptcy when it had so much real estate on the books? The value of the real estate went to repay bond holders, who got shares in the new company as partial repayment for the old company's debts. Nothing was left for stockholders.)
Youll find similar liquidation premiums at many other retailers. Dillards stock, for example, recently traded for $19.80 per share. Deutsche Banks Taylor, however, puts the underlying value of Dillards real estate at anywhere from $41 to $69 per share, a markup of 100% to 250%. Markups at stores like the discount retailer ShopKo Stores (SKO, news, msgs), the supermarket chain Winn-Dixie Stores (WIN, news, msgs) and the upscale retailer Saks (SKS, news, msgs) run anywhere from 90% to 170%.
| Land-rich retailers | | Name | Recent price* | Real estate value** (low) | Real estate value** (high) | | Dillard's (DDS, news, msgs) | $19.85 | $41.39 | $69.35 | | ShopKo Stores (SKO, news, msgs) | 17.69 | 27.04 | 47.77 | | Winn-Dixie (WIN, news, msgs) | 4.35 | 5.02 | 8.74 | | Saks (SKS, news, msgs) | 12.31 | 12.88 | 23.49 | | Kmart Holdings (KMRT, news, msgs) | 82.08 | 81.49 | 152.95 | | Sears Roebuck (S, news, msgs) | 39.84 | 30.05 | 55.38 | | Federated Department Stores (FD, news, msgs) | 45.28 | 33.16 | 51.79 | | Toys R Us (TOY, news, msgs) | 16.53 | 8.69 | 17.09 |
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* As of 9/3/04. ** Dollars per share.
Source: Deutsche Bank Securities.
Land prices rise along with competition
You can trace this jarring disconnect at our nations retailers back to three factors. - Poor business models: Most retailers trading below the value of their real estate are either giant department store chains or supermarkets. These are precisely the kinds of stores wounded by competition over the years from the likes of discount chains like Wal-Mart, Kohl's (KSS, news, msgs) and Target (TGT, news, msgs), and specialty retailers like Abercrombie & Fitch (ANF, news, msgs) and The Gap (GPS, news, msgs). This means the share prices of department stores and grocery stores have underperformed.
- Good real estate deals: But these very same retailers are sitting on cheap leases or property they acquired years back from developers. The developers offered discount leases with juicy renewal options, so their malls and shopping centers would have anchor tenants like Bloomingdales to draw the crowds. The average department stores rent is half that of the retail sector overall.
- Rising real estate value: Meanwhile, prime retail space has grown scarce, driving up the value of the dinosaur stores and their leases, says Taylor.
The gap between asset values and share prices widens even more if you throw in the value of furnishings and equipment. Liquidation premiums for Toys R Us and Federated Department Stores (FD, news, msgs) leap from near zero, to 27% to 41%, once you factor in furnishings discounted at 25% to 50% of book value, according to Taylors arithmetic.
Hard to realize the gains
Can investors really get at these juicy gains? The quick answer is no. (But the underlying real estate has value for investors nevertheless, for reasons well get to in a second.)
The big problem, says Taylor, is that its tough for retailers to ring the register on their real estate and leases, which can legally be transferred to other retailers. It is easy for us to say there is gobs of value in Dillards, but is the company going to do anything to realize it? asks Taylor.
And much of that real estate value may be ephemeral. Sell off stores, and a retailer still has to pay rent, points out Steve Romick, a portfolio manager at First Pacific Advisors, which consistently turns in solid returns with its value approach to investing. Besides, he says, sales can sacrifice the competitive advantage of engaging in drawn-out price wars against competitors.
And what about taxes on any gains from real estate sales? No company has invented a way to realize the value of the real estate without taking the tax hit, says Gregg Tenser, a value investor with NWQ Investment Management, which manages more than $20 billion in assets.
Downside protection
Still, the value of real estate is crucial for the downside protection it offers at struggling retailers like the eight on our list.
Sears is a popular holding at many successful value shops these days. At $39 per share, it trades for $15 below the potential value of its real estate. This helps investors sleep at night, knowing they wont lose everything if management missteps in its efforts to turn around flagging sales. To spur growth, the retailer is moving into relatively untested waters, rolling out Sears Grand off-mall superstores which offer an expanded line up of basics like food and magazines. Sears is also experimenting with new lines of apparel, and it might fail here, too.
It is the same story with Toys R Us, Federated, Saks and ShopKo. All are trying to right some wrongs, and their real estate holdings offer a cushion against turnaround plans that go awry.
In a nightmare scenario, Toys R Us is not going to go away because the real estate is worth more than the current share price after debt, says Tenser of NWQ Investment Management, which holds the stock. The company is closing 100 to 150 stores and clearing warehouses of toys that wont sell. It is also mulling a sale of its global toy business, to highlight the growth potential of its Babies R Us division, which Tenser thinks could be worth $10 per share alone.
Federated, which runs venerable department store chains like Macys and Bloomingdales, has been hit hard by more modern retailers over the years. Consequently, its reinventing stores to bring in a younger crowd -- adding contemporary fashions, new lighting, sound systems and dressing rooms. It should finish most of its stores through next year.
In case this fails, investors know Federateds huge real estate holdings are there to protect against disaster. Its the same story at ShopKo, which is renovating stores to improve sales, and Saks, which has posted solid sales growth but still cant cut costs enough to boost profit margins.
That protection is crucial
Prospects are so shaky at Winn-Dixie and Dillards, investors definitely need the real estate value to venture into these shares. Its a big plus for Jean-Pierre Conreur, who manages the Tocqueville Small Cap Value fund (TSCVX, news, msgs), which has a large position in Winn-Dixie.
Conreur likes the grocery chain because it looks so cheap. It has a minuscule price-to-sales ratio of .05, compared to the norm of 0.1 to 1.5 for supermarket chains. He also thinks it has the potential to go up threefold as a turnaround plays out. The chain is closing 150 weaker stores and focusing on fresher perishables and better service to try to take share back from Wal-Mart. Winn-Dixie is an ideal turnaround, believes Conreur.
Goldman Sachs analyst John Heinbockel has doubts, warning that the brutally competitive nature of the supermarket business in the South poses a real challenge. (Value investors often like it when sell-side analysts hate their stocks because it suggests the shares are near a bottom.) But if Winn-Dixie fails, Conreur knows he has a backstop. Winn-Dixies leases, equipment and furnishings could be worth $8 to $15 per share in liquidation, estimates Deutsche Banks Taylor. The stock recently went for $4.70.
Dillards, a department store chain with operations in the Southeast, Southwest and Midwest, has seen sales decline for the last four fiscal years. Sales may be lower in fiscal 2005 as well. Still, the company has 328 stores in 29 states, which offers potential suitors an easy way to penetrate its markets. But business is so bad, owning the stock is essentially a bet on a buyout -- and the potential gains are dazzling.
May Department Stores (MAY, news, msgs) recently paid one times sales for Marshall Fields. If Dillards were bought for 90% of sales, Dillards shareholders would get a triple -- or $82 per share, says Taylor. Its a play for gamblers only; it is far from certain the Dillard family, who control the voting shares, would sell.
And what about Kmart? Edward Lampert, whose ESL Investments controls the company after managing the turnaround, isnt plowing money back into stores. Thats a sign he may sell off most of them, return much of the money to shareholders through dividends and stock buybacks, and keep Kmart as a holding company to house other businesses. Kmart has lots of juicy long-term leases at below-market rents, so Lamperts pickings are rich.
Indeed, Taylor views Kmart as more of a land bank than a retailer. In essence, with all that real estate, it doesnt matter if Kmart can survive against Wal-Mart and Target, says Taylor.
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