Sears Hometown and Outlets Offers Investors a Do-Over

Sears Hometown and Outlets Offers Investors a Do-Over

Though it came out of the IPO gates incredibly strong for several months, Sears Hometown and Outlets has since erased almost all of its capital appreciation since the company spun off from parent Sears Holdings . The shift in market appreciation comes from multiple sources, from too much affiliation with its parent company (a retail pariah), to weaker-than-expected quarterly results, to share redemptions from Sears Holdings CEO Eddie Lampert's hedge fund. As a result, the stock price has declined 30% in three months, and is nearly half of its $56-per-share high in early June. The kicker is that company fundamentals remain intact, and investors could see things trend back up shortly.

Not your father's Sears
While This doesn't excuse the company's lackluster performance in the past two quarters, much of Sears Hometown and Outlets' trouble is due to its name. Sears Holdings is a completely different story of a stock, with the vast majority of its value in tremendous real estate holdings (a still-compelling story, despite naysayers). Its retail operations, in the meantime, are in the toilet. Investors and analysts seem to think that since both companies have the name Sears, both are dead retail businesses. Additionally, the spinoff may suggest that Lampert is "unloading" undesirable parts of the business to focus on the real-estate portfolio.

Both of these assumptions are absolutely incorrect, which is fantastic for investors given current stock prices.

For one thing, Lampert and his fund's investors own substantial positions in both Sears and Sears Hometown. With nearly 50% of the latter, it is illogical to think that Lampert considers Sears Hometown to be unappealing. It is much more likely that he finds the company to be the future of Sears' retail operations. Furthermore, Sears Hometown operates in an entirely different fashion from its former parent. Many of the company's stores are franchised or in the process of becoming franchised. While this limits top-line sales growth, it improves gross margin over the long term and transitions Sears Hometown into your typical "capital-light" retail business.

Another factor in play is that although Sears Holdings shoppers are dwindling (along with store count), the selling off of stores and transition to a real estate company will divert some existing shoppers -- those loyal to the Kenmore, Craftsman, and Diehard brands -- to Sears Hometown, where the brands are drifting anyway.

Need more reasons?

More reasons
Take a look at Sears Hometown's balance sheet. The company has $250,000 in long-term debt. One oft-cited issue with Sears Holdings is that the company cannot continue to fund its retail operation because it's buried in debt. Sears Hometown obviously does not have this problem, even though the company isn't cash-rich by any means. It held just $23 million in cash as of the last quarter.

As things stand now, Sears Hometown is back at its spinoff price with the same long-term earnings potential it had one year ago. The company trades at an EV/EBITDA under eight times and a price to sales of just 0.27 times. Get over the pariah branding: Sears Hometown is a good-looking business.

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Fool contributor Michael Lewis owns shares of Sears Hometown and Outlet Stores and Sears Holdings. The Motley Fool owns shares of Sears Hometown and Outlet 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.

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Originally published