Buy Netflix, Sell Sears
It's true. Three weeks into 2012, the parent company of disappointing discounters Sears and Kmart is leading the way with a 54% surge. Netflix isn't doing too shabby with its 45% pop. The S&P 500's other 498 components must be shaking their heads.
However, it would be wrong to simply label the two companies as comeback kids. They each have a long way to go before achieving redemption.
Netflix might do it -- in time. There's no way that Sears will make it back.
The softer side of Sears
I was reading a Fortune article from six years ago, when Eddie Lampert was still perceived as the meandering retailer's savior. Here's a passage that should be stapled to the syllabus of any worthwhile business school.
'What's the benefit of that?' he asked again and again. 'What's the value?' He shot down a modest $2 million proposal to improve lighting in the stores. 'Why invest in that?' He skewered a plan to sell DVDs at a discounted price to better compete with Target and Wal-Mart. 'It doesn't matter what Target and Wal-Mart do,' he declared.
At the time, this was being offered up as proof of Lampert's shrewd yet savvy business ways. Sears, after all, had seen its shares climb 30% higher in its first year under the hedge fund rock star's watch.
We now know how badly he got this. Sears and especially Kmart needed the makeovers to woo new shoppers. A lighting upgrade may have been the least of either chain's shortcomings, but ignoring that was symptomatic of the cost-cutting nature that ignored the capital expenditures required to make them appealing to shoppers again.
Ignoring the cheap chic magnetism of Target (NYS: TGT) and the pure discounting bliss of Wal-Mart (NYS: WMT) simply led disgruntled customers elsewhere. Who cares what Target and Wal-Mart do? Shoppers do, Lampert. That's who.
"Now the question is this: Is Lampert's Sears acquisition another inspired work of genius, a stepping stone to Berkshire Hathaway -- like wealth creation for public investors," the 2006 Fortune article eventually asks. "Or has he finally gone a step too far?"
Well, the stock was at $121 at the time of the article. Even after this month's inspired bounce, the stock has still shed more than half of its value. Sears Holdings went from being a profitable cash cow to a deficit-plagued also-ran.
The damage has been done. The brands are now reputational liabilities than assets. When's the last time you went shopping at Kmart? When do you plan on going back?
The stock has been rallying this month on the heels of SEC filings showing that Lampert has bought $159 million worth of the stock, though most of it was purchased from his hedge fund. The speculation here is that Lampert will take the company private. Maybe he can gut it for its real estate value, but it's obvious that he's not going to be the one to turn it around. Lampert made some brilliant investing decisions before he married Kmart to Sears, but he's not going to be able to resuscitate two dying brands. Store-level comps have fallen every year under his watch, and it's too late now.
The irony for the poor saps bidding up the stock this month is that it will get to the point where Lampert may prefer to be a seller than a buyer. He gobbled up some shares earlier this month when the stock was much cheaper. Why would a shrewd hedge fund manager buy a dying Sears Holdings whole now?
Stay away if you know what's good for your portfolio.
Nutty about Netflix
The demise of Netflix's once killer brand came a lot quicker than the slow bleeding at Sears Holdings. The video rental giant was on top of the world just six months ago, hitting new highs as analysts and investors cheered on the announced price hike.
Customers had the final say -- as they do now with Sears Holdings.
The difference here is that Netflix should bounce back. It may not happen this week. Wednesday night's quarterly report has the ripe potential to be a colossal disappointment given the net defection rate that began toward the end of the third quarter. Aggressive international expansion hasn't come cheap.
However, if we can look past this week, there's reason to believe Netflix will begin growing its global subscriber count as 2012 plays on.
As bad as the price hike and the short-lived Qwikster fiasco were for couch potatoes, folks are still big on streaming through Netflix. A whopping 2 billion hours of premium video consumption was Netflix's handiwork during the fourth quarter. No one is even close. Consumers may not forget, but they are apparently willing to forgive.
Can Sears Holdings say that?
Despite last year's comedy of errors, Netflix has the advantage of scale. Just as Wal-Mart has the ability to undersell rival discount department stores through its gargantuan size and use its informational superiority to turn inventory over faster than the competition, no one will ever be able to match what Netflix can pay studios for content under its low-cost unlimited smorgasbord model.
Cynics can argue that Netflix doesn't own the content -- just as Wal-Mart doesn't manufacture its wares. This doesn't matter. There's an undeniable advantage in the model that will win out over time.
Kmart never had that. Sears hasn't had that since your great-grandfather stopped working there.
Netflix will live on. Sears Holdings will come undone.
Netflix would still have to triple to reach its summertime highs, and that's certainly not going to happen soon. However, once it gets past any bad news that it may dispense during this week's quarterly report all of the right ingredients are there for a gradual return to favor.
As for Sears Holdings, Lampert may very well take the holding company private to swallow his pride out of public scrutiny, but it certainly won't be for much of a premium above this month's speculative buzz. The more likely scenario is that the store closings escalate as both Sears and Kmart continue to fade -- along with its share price.
I'm sticking to my bullishCAPScallon Netflix in Motley Fool CAPS. I'm also initiating a bearish rating on Sears Holdings this morning, given the limited upside and vast downside.
Instead of worrying about the downside of two completely different American companies, read up onthree American companies set to dominate the world. The report is free, but it won't be around forever.Check it out now.
At the time this article was published The Motley Fool owns shares of Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of Netflix and Wal-Mart Stores. Motley Fool newsletter services have recommended creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.Longtime Fool contributor Rick Munarriz has been a Netflix subscriber and shareholder since 2002. He does not own shares in any of the other stocks in this story. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.
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