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Warren Buffett has done quite well investing in the retail sector. His investments have included Nebraska Furniture Mart with its three locations in Nebraska, Iowa, and Kansas, and more recently Wal-Mart Stores (NYSE: WMT). Everyone knows Wal-Mart as the world’s largest retailer with approximately 11,000 stores in 27 countries.
But, for many good reasons, Buffett has avoided Sears Holding (NASDAQ: SHLD). Sears is led by Eddie Lampert, who greatly admires Warren Buffett. Lampert is also the largest Sears shareholder.
Some have said that Lampert acquired Sears Holding to function in the capacity of a holding company, similar to Buffett’s Berkshire Hathaway (NYSE: BRK-A). There is logic to that as retail operations, when managed well, can deliver what Buffett wants. An obvious feature here is “the float,” the period between when money is collected and when it must be paid.
Buffett finds this aspect of insurance companies to be especially appealing.
It can happen in retail chains, too. An insurance firm collects the premium income, invests it, and then prospers by how much more it makes over what it has to pay out in claims. Much of that is based on the “time value of money,” the basis for all investing. For a store it is much the same: sell the goods and services immediately and then pay the bills much later, profiting from the time value of money by playing the float in the interim.
Poor Sears Management
But that, along with many other things, is not working for Sears Holding.
It does, however, for Wal-Mart. That is why Buffett is a major shareholder. This is best shown by the cash conversion cycle, the number of days it takes a retailer to move its product off the shelves. The faster the better, as money comes in that much quicker.
The cash conversion cycle or Wal-Mart is 13.68 days. It is 111.47 days for Sears Holding.
Buffett also likes to see a return-on-equity ratio of at least 20% for three consecutive years. The return-on-equity for Wal-Mart is 21.40%. For Sears Holding, it is a negative 219.80%. The return on equity shows how well the money invested by the owners is performing, and for Sears Holding, that is not very well.
Much of that has to do with the management of Sears Holding.
When Buffett acquires a company, the management is generally left in place. The company was run so well that Buffett wanted to buy it, so why change the leadership? Eddie Lampert, whose background is in finance, put himself in charge of Sears Holding. The result?
Lampert comes in last as a chief executive officer in terms of employee reviews by Glassdoor.
Sears: Lots of Debt, No Dividend
Buffett also likes to be paid to be the owner by assets he purchases. That comes from the free cash flow, and the dividend payments. These funds being kicked off can then be used to acquire other assets. Wal-Mart has a dividend yield of 2.28%. Wal-Mart is also a dividend aristocrat, which means it has a history of increasing the amount of the dividend annually for at least 25 consecutive years.
Sears Holding does not pay a dividend.
But Sears Holding is loaded down with debt, which Buffett abhors and tries to avoid. The Oracle of Omaha feels that a business that is managed well will generate enough cash to pay its bills and finance growth. Wal-Mart has a debt-to-equity ratio of 0.70. It is 0.32 for Berkshire Hathaway.
The debt-to-equity ratio for Sears Holding is 41.17, stunningly high for a collapsing retailer that has such a difficult time selling its goods.
Sears Holding, J.C. Penney (NYSE: JCP), Bon-Ton Stores (NASDAQ: BONT) are all floundering for a myriad of reasons. The companies that Buffett has invested in, such as Wal-Mart, are flourishing. It is certainly no mystery why Buffett has invested in Wal-Mart rather than Sears Holding. The big question for investors and speculators is how much longer can retailers like Sears, J.C. Penney and Bon-Ton Stores survive?
Jonathan Yates does not have a position in any of the stocks mentioned in this article.
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