G5 Investment Group
Matt Nutsch Renis Kacani Melody Seely Ashley Green Wiley Eagle
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G5 Investment Group
Buy
Stock Data
Price (52 weeks) Symbol/Exchange Beta Fully Diluted Shrs Average Daily Vol Current market cap Book Value / Share Current ratio $31.21 - $55.90 S / NYSE 1.3 230.4 million 5,028,000 shrs 10.82B $28.3 1.32
Executive Summary
Sears is following a differentiated approach in a competitive industry. Consequently, Sears has lagged behind other broadline retailers such as K-Mart, Target, and Wal-Mart. Should Sears adjust its marketing approach, it would have great potential for success. Growth prospects for Sears include continuation and growth of sales and expansion. The development of subsidiary brands such as Lands End and the acquiring of 61 of-mall stores from K-Mart and Wal-Mart. of new stores abroad will fuel this growth. Financing the acquisitions should not be overly burdensome for Sears, given the companys large cash. Also, the companys Z-Score of 5.9 will provide easy access to financing if needed Sears has began to shift to an off-mall emphasis for its stores as it acquired stores from K-Mart and Wal-Mart. It has named this process Sears Grand and it is progressing well for the company. This shift in emphasis will also sustain Sears growth. Sears performance is highly correlated to market factors. It is subject cycles in the industry as well as economic fluctuation in the system as a whole. Sears sales are highly seasonal and the company heavily depends on holiday season performance. Sears financial statements are reasonably transparent and more or less free from error. They report information on a quarterly basis. Sears fiscal year ends on December 31st. As a publicly held corporation they publish 10Q quarterly statements and 10K annual statements are in accordance with SEC regulations. We have analyzed Sears using three categories of ratios: liquidity, profitability, and capital structure. In the liquidity section we calculated the current ratio, quick asset ratio, receivables turnover, inventory turnover, and working capital. In the profitability section we calculated gross profit margin, operating expense ratio, net profit margin, asset turnover ratio, return on assets, and return on equity. In the capital structure section we calculated debt to equity ratio, times interest earned, and debt service margin.
We valuated the company based upon five valuation models. Those models were the Method of Comparables approach, the Residual Income Method, the Discounted Dividends Model, the Free Cash Flows Model, and the Abnormal Earnings Growth. Based upon all of these valuation methods except the Discounted Dividends Model, we have determined that the company is undervalued. Thus we recommend Sears as a buy as current price is undervalued to our predictions based on the valuation methods. These valuations methods were performed using data from November 1st of 2004. On November 17th K-Mart, one Sears main competitors, announced that it is going to buy Sears Roebuck & Co. for $11 billion. Immediately prior to this announcement, Sears stock was selling for $45.20 per share. The day of the merger, Sears stock jumped $7.79 per share. We estimate that K-Mart believes that it can justify this additional $7.79 per share due to synergies from the merging of the two companies. In this evaluation we learned that Sears uses a differentiated strategy. We also learned that the industry that Sears operates in is more competitive than differentiated. This could explain why Sears has not been performing extremely well in recent years. After the merger we can expect to see a more competitive K-Mart strategy integrated into the traditional Sears, differentiated strategy. We can also expect that many previously closed, freestanding K-Mart stores reopened as Sears, as the new company plans to shift its focus away from the mall model.
the retail market, behind: Wal-mart Stores Inc., Target Corp., Kohls Corp, and JC Penney Company Inc. In 2003, the company was divided into three domestic segments: Retail and Related Services, Credit and Financial Products, and Corporate and Other. In addition the company has one international segment, Sears Canada. The Retail and Related Services segment focuses principally on merchandise sales and supporting activities, such as: service contracts, product installation, and product repair. The Credit and Financial Products segment manages the domestic portfolio of MasterCard and Sears Card receivables. This segment was sold in November of 2003. The Corporate and Other Segment includes the operations of Sears Home Improvement Services. Sears Canada includes its own retail, credit and corporate operations. Sears competitors have similarly segmented company structures (http://finance.yahoo.com, 2004). Sears operates both specialty and full-line stores. Its customer operations include major sales from online and catalog marketing. Sears 871 full-line stores offer a wide range of products for the home. These include appliances, clothing, jewelry, automotive supplies, power tools, and garden equipment. Sears.com is Sears implementation of internet marketing and offers a limited assortment of home and accessories merchandise. In addition to its full-line stores, Sears operates 1,100 specialty stores, 792 primarily independently owned stores, 245 Sears Hardware Stores, 8 furniture stores, 18 The Great Indoors stores, 45 Sears Outlet Stores, and a commercial sales division (http://finance.yahoo.com, 2004).
million service calls made annually (http://www.marketresearch.com, 2004). Along with being a high service provider Sears also keeps it products versatile by offering differentiation with their product line. Sears Roebuck and Co. is a leading U.S. retailer in apparel, automotive, home products, and service. As well as offering a wide range of products, they are also able to compete on the fact that they are a low-pricing retailer. Although, there are existing competitors in this same industry, they are doing a great job differentiating their company, which is helping them to continue growing in this industry.
Conclusion
Sears Industry is differentiated. This is evident due to many factors. First, it offers a wide range of products, is a low-price retailer, and provides a huge magnitude of services. These differentiate Sears from other low cost retailers. Second, Sears is a company of gigantic proportions and the barriers to entry into its business are immense. Third, Sears uses great customer service to deter customers from switching to competitors products, this focus on customer service acts to mitigate the effects of substitute products. Fourth, the company has forged strong ties with its suppliers, giving Sears a competitive advantage. Finally, Sears has developed a robust and loyal customer base, thus giving it power as their supplier of consumer goods.
in Brand Image. Sears, Roebuck, & Co. has a rich, long history
that dates back more than a century to when R. W. Sears sold his first batch of watches. Since its founding in 1886, Sears has endeavored to foster a brand image of strength, reliability, and good customer service (http://www.searsarchives.com, 2004). This image persists today not only in connection with the stores retail chain, but also in many of the companys subsidiaries.
Superior
innovation and has focused on customer service as a core competency. It has continually sought to differentiate itself from its competitors through customeroriented practices. Such practices range from designing its stores around merchandise placement to staffing the most experienced associates during the peak hours of evenings and weekends, thereby allowing it to turn superior customer service into a competitive advantage (http://www.searsarchives.com, 2004).
Superior
establishing its own suppliers. In doing so it has afforded itself not only the opportunity to provide a higher quality of products, but also greater control over the merchandise that it sells. Brands owned by Sears include Diehard, Craftsman, Kenmore, and Lands End. Sears also implements 1,100 specialty stores that are dedicated to serving the specific needs of their customers (http://finance.yahoo.com, 2004).
traditional shift away from its historically famous catalog series. Internet sales
have grown and offer customers the opportunity to pick their products up at a store location or have their purchases delivered to their doorstep. As a result of these key success factors, Sears, Roebuck, & Co has managed to persevere for more than a century. These translate into advantages that when paired with devout customer loyalty, have allowed Sears to grow, develop a firm customer base, and force out smaller competitors. While Sears tradition and long history have been boons when it comes to maintaining customer loyalty, the companys rigidity and unwillingness to change have allowed low cost multi-line retailers, such as Wal-Mart and Target, to capture a significant share of the market. Slowly these low cost retailers are forcing Sears out of the Department & Discount Retail industry into the peripheral Specialty Retailing and Catalog/Online Retailing industries (http://www.marketresearch.com, 2004).
SWOT Analysis
Sears Roebuck and Co. held the #1 position among retailers for 40 years (Prentice-Hall 2003). The company is organized into four major segments: retail and related services; credit and financial products; corporate and other and Sears Canada (Multex Investor, 2003). In June 2002, Sears acquired Lands' End, Inc, a company specializing in traditionally-styled casual clothing for the entire family, footwear, accessories, soft luggage and home products (Multex Investor, 2003). This acquisition seems to be a win-win deal. Lands' End became a wholly owned subsidiary of Sears and will gain an even larger direct sales customer database while Sears will gain a brand that is known for quality and service. Lands' End has traditionally sold its products through a flagship and specialty catalogs and it has gained a wide presence on the Web (Hoover's, 2002). Besides gaining a respected brand, Sears also gains the direct marketing expertise and experience a company that has a reputation of being one of the most efficiently run direct marketers in the world (Scheraga, 2002). All of Sears direct marketing efforts are now handled by Lands' End (Scheraga, 2002).
Internal and external environment scans can begin with a SWOT analysis. (SWOT - Internal Strengths and Weaknesses; External Opportunities and Threats).
Internal Strengths:
The marriage of Sears and Lands' End gives Sears a much-needed boost in expertise in the arena of direct marketing and sales and also of gaining a strong presence on the Internet (Halligan, 2002). This merger has strengthened Sears key success factors of superior product quality and more flexible delivery. This marriage also gives Lands' End face-to-face consumer exposure wherein consumers can try on the clothes in their Sears store before buying (Scheraga, 2002). Sears now has several known brand goods, e.g., Craftsman, Lands' End, Kenmore and all of their merchandise that carries their own brands, such as Lands' End Oxford Express brand of shirts (Halligan, 2002). Sears has an extensive customer database (Prentice-Hall, 2003). This is due to the companys key success factor of superior customer service.
Internal Weaknesses:
Sears has allowed their reputation and sales volume to plummet because they did not keep up with the changing market environment. Too much diversification within the company; the focus was moved away from retail services to providing all sorts of other services, such as investment and banking (Prentice-Hall, 2003). Many of the retail stores are in disrepair and not reflective of the needs of today's consumer (Prentice-Hall, 2003). Operating expenses are higher than competitors (Prentice-Hall, 2003).
Opportunities:
The acquisition of Lands' End represents an enormous opportunity to the Sears Corporation. It is a brand that has a repatriation of quality and service. Halligan (2002) advises Sears' executives to find the 'silver bullet brands in the brands offered by Lands' End and to capitalize on these to increase revenues. 9
Some possibilities are the Lands' End Custom and Lands End Swim Finder. They should also capitalize in Lands' End Guaranteed Period service (Halligan, 2002). The reputation of the Lands End brand contributes to Sears brand name, thus bolstering its key success factor: investment in brand image.
External Threats:
The retail industry is highly competitive with both old names, like Wal-Mart and K-Mart taking the lead above Sears and with new companies opening both on the Internet and in physical buildings (Prentice-Hall, 2003). Departments, like women's apparel are constantly under siege from other stores who capitalize on the notion of quality clothing and sales, such as Liz Claiborne (Prentice-Hall, 2003). More and more discount stores are opening, further driving sales in certain departments at Sears lower, such as all apparel departments (Prentice-Hall, 2003). There are two levels in the external environment: the macro-environment, which incorporates all of the major sectors, such as political aspects, sociopolitical aspects, technological aspects, socio-cultural aspects and economical aspects, and the micro-environment, which includes all the stakeholders relative to a specific organization to include shareholders, partners, financial institutions, regulators, customers and competitors. The major issue at this writing is the economic condition of the country. We are in an economic downturn, still. This means the company must take steps to reduce costs but increase revenue. There are no political issues that would have a dramatic impact at this time. Social values, however, have changed. Consumers are looking for convenience and value-added products and services. Lands' End Guarantee Period is a value-added service and should be emphasized. In fact, Sears could initiate the very same guarantee; it offers this on Craftsman tools but not for any other product. Technology continues to change and Sears has made good use of it, often spending more on technology
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than competitors. New laws and regulations are always a possibility. The company must simply deal with them as they emerge.
Accounting Analysis
I. Identify Key Accounting Policies
Sears and Roebuck is a very broad company that has the opportunity to be very versatile when it comes to accounting choices. It is a full line retail store that consists of appliances, electronics, home improvement and home fashions. This broad base includes apparel and accessories, Sears Auto Centers, and online sales from Sears.com. A couple activities that need to be taken into account are activities that overall hold the companies nature are, one that consists of administrative activities, the costs of which are not allocated to the companys business. The other is the home improvement services (primarily siding and windows through Sears Home Improvement Services. (http://biz.yahoo.com, 2004) In the retail industry the management of inventory is a key success factor. This is something that Sears has over the years learned to estimate very well, which has allowed it to turn over increasing numbers. Total Revenues for the 13 and 39 weeks ended September 27, 2003 were 9.8 billon and 28.9 billion compared to the previous year that was at 9.7 billion and 28.8 billion. (http://biz.yahoo.com, 2004) Within the accounting practices of inventory and also revenues and expenses, there are not a lot of ways that Sears can manipulate the numbers; everything is pretty much straight forward within there accounting procedures. Now on the flip side there are some ways that Sears is able to estimate numbers, which makes them able to manage the numbers to look better. For one example, selling and administrative expenses as a percentage of total revenue were 22.8% for 13 week ending period September 27, 2003, compared to 24.2% the prior period. There is a certain amount of expense that cannot be avoided from administrative activities but there are some like their marketing research, which they include in administrative expenses. In
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2003, selling and administrative expenses for Sears totaled $9,111,000,000. Another way that Sears is able to adjust numbers the numbers for good or bad is the allowance for uncollectible accounts, these estimates can effect the company for the good or the bad depending if they are underestimates or overestimated. Sears allowance for uncollectible accounts in 2003 was $1,747,000,000. Overall Sears does and good job in their accounting procedures. Hypothetically, there are ways that they are able to manipulate numbers. However, the companys financial statements do a good job giving accurate information that represents the truth about Sears and Roebuck. It does this by providing timely and relevant accounting numbers to current and potential shareholders.
Inventory valuation
Approximately 88% of merchandise inventories are valued at the lower of cost or market, with cost determined using the retail inventory method (Rim) under the LIFO cost flow assumption (Sears 10K Filing, 2004). Management judgment
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and estimates for the calculation of RIM include merchandise markon, markups, markdowns, shrinkage, and vendor allowances. These judgments and estimates have an impact not only on the ending inventory but also on gross margins.
Self-insurance reserves
The Company uses a combination of third-party insurance and/or self-insurance for a number of risks including workers compensation, automobile, product and general liability claims (Sears 10K Filing, 2004). The companys liability reflected on the consolidated balance sheet represents an estimate of the ultimate cost of uninsured claims incurred as of the 2003 10K balance sheet date (Sears 10K Filing, 2004).
considers the current condition of the portfolio and factors such as bankruptcy filings, historical charge off patterns and other portfolio data (Sears 10K Filing, 2003). The management reviews these calculation to decide if additional analysis are required, based on economic events. In 2003 Sears earmarked $1,747,000,000 for uncollectible accounts (Sears 10K Filing, 2003).
Income taxes
The company provides deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax bases of assets and liabilities based on currently enacted tax laws (Sears 10K Filing, 2003). The tax balances and income tax expense recognized by the company are based on managements interpretation of the tax laws of multiple jurisdictions (Sears 10K Filing, 2003). Income tax expense also reflects Sears best estimates and assumptions regarding the level of future taxable income, interpretation of the tax laws, and tax planning. Comments on Sears Accounting Strategy: Sears accounting policies are similar to the norms in the retail industry. The only major difference between Sears accounting policies and other firms in the retail industry is the treatment of Allowance for uncollectible accounts. This is because not all the firms in retail industry have issued their own credit cards. However, similarities for the treatment of Allowance for uncollectible accounts exist between Sears, Wal-Mart, Target and JC-Penney. The reason for these similarities is that while not all of these retailers offer financing on their products 14
via store credit cards, they do provide financing from external companies. Sears Roebucks managements estimates of the financial statements have in the past reflected and do reflect its best judgment based on the consideration of available facts and circumstances. The company has tried to maintain its accounting policies and keep its estimates realistic and similar to the norms of the retail industry. However, these policies and estimates have required and may require adjustment as additional facts have become known or as circumstances change. For example, past and future changes in tax laws, changes in projected levels of taxable income, and tax planning could affect the tax rate and tax balances recorded by the company. Sears has changed some of its accounting policies. The company changed its method of accounting for goodwill in 2002 and its methods of accounting for credit card securitizations, derivative instruments and hedging activities in 2001. (These changes were required by new accounting standards.) Under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, goodwill is no longer amortized. This change showed as a negative $208,000,000 on the 2002 balance sheet (Sears 10K Filing, 2003). Prior to the start of 2002, the company followed the provisions of Accounting Principles Board Opinion (APB) No. 17, which required that goodwill be amortized by systematic charges to income over the period expected to be benefited (Sears 10K Filing, 2003). That period ranged from 5 to years. In addition, on March 31, 2001, Sears adopted the requirements of Statement of Financial Accounting Standards (SFAS) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which superseded SFAS No.125. (Sears 10K Filing, 2003). Under SFAS No. 125, the companys securitization transactions were accounted for as sales of receivables, and SFAS No. 140 established new conditions for a securitization to be accounted for as a sale of receivables. Moreover, in the first quarter of 2001, sears adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The adoption of this new accounting standard did not affect Sears net income. In 2001, the cumulative 15
effect of the change in accounting principle reduced other comprehensive income by 262 million dollars. This included the reclassification of other comprehensive income of a 228 million dollars deferred loss on an interest rate swap that was terminated in 1997 and the recognition in other comprehensive income of 34 million dollars related to a cash flow hedge (Sears 10K Filing, 2003). Also, sears plans to change its method of accounting for its domestic defined benefit (explained above) plans to immediately recognize any experience gains or loss in excess of the 10% corridor and to value plan assets at fair value. This method of accounting in contrast with the above accounting methods is not required to be changed by any new accounting standard. The reason for change is because the company believes that the new method is preferable in regard to changes made to its domestic benefit plans to discontinue providing pension and retiree medical benefits to associates under the age of 40 as the new policy accelerates recognition of events which have already occurred. (Sears 10K Filing, 2003). But under this new accounting method, Sears pension expense in future periods may be more volatile as this method accelerates recognition of actual experience.
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of 2003. Even though this might decrease the amount of variable rate risk, Sears still felt it necessary to pass this information along in hopes of making their company more attractive to investors. Sears also discloses information about their accounting policies and procedures to the public. The SEC deems it necessary to disclose significant accounting policies. They explain the sale of their credit and financial products business as mentioned above. They also give explanations as to how the fiscal year is realized. Sears has a different way of figuring the fiscal year by ending the fiscal year as the Saturday nearest to December 31. Also disclosed are estimates for the year including inventory valuation, allowance for bad debt, depreciation, etc. Sears explains in detail the borrowing practices. They disclose the interest rates and maturities of their long-term debt securities listed and separated by their own companies. This disclosure helps with the transparency of the companys liability section on their balance sheet. Their total liabilities decreased significantly from $43,656 in 2002 to $21,322 in 2003. This decrease is shown through the amount of long-term debt and capitalized lease obligations, which is stated as $4,218 in 2003 from 2002 being $21,304. From the sale of the business previously mentioned they were able to decrease their amount of longterm debt. Another key disclosure seen in the notes section on the 10-K is earning per share ratio:
(Millions, except per share data) Net Income (1) Average Common Shares Outstanding Dilutive Effect of Stock Options Total Average Common Shares Outstanding Earnings per Share: Basic Diluted $11.95 $11.86 $4.34 $4.29 $2.25 $2.24 286.3 320.7 328.5 2003 $3,397 284.3 2 2002 $1,376 317.4 3.3 2001 $735
326.4
2.1
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The disclosure of the earnings per share ratio sheds light as to why the ratio for this year is almost three times as it was the year before. With an increase of $3,000 in Treasury Stock in 2003, this leads us to conclude that the buyback of the common stock led to the decrease in shares outstanding from 320.7 in 2002 to 286.3 in 2003. In the year of 2003 there was an increase in Net Income due to the gain on sale of the credit and financing business. With the increase in Net Income and the decrease of shares out standing, this ratio is then justified with the significant increase. Overall Sears Roebuck & Co. discloses information very well. Not only do they show the calculation they made and the numbers that got them there, but they also explain in words what is going on within their company and try to allow investors to make educated opinions about their company.
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Another red flag is many fourth quarter adjustments. Sears Roebuck & Co. should not have a large number of 4th quarter adjustments to increase the value of there company to its customers and investors. This red flag can be found by looking at quarterly statements and making sure that Sears did not fix the numbers on there statements in the 4th Quarter to make there year-end totals look better than they should. The types of adjustments that should be looked for are large number changes in current and non-current assets or liabilities on the balance sheet. The adjusting of these numbers in the last quarter is a key red flag, and this ensures the quality of Sears accounting. A third red flag is called a related party transaction. Transactions of this type are when another company or a branch of Sears purchase or sell in large amounts, and in doing this, gets rid of unwanted or outdated products or services. In doing these transactions it allows Sears to rid themselves of items not wanted on there statements, once again enhancing their statements. These are some potential red flags of Sears Roebuck & Co. The identification of these red flags is necessary to maintain a high quality of accounting to the public. The high quality of Sears accounting keeps there name out of the public eye for the wrong reasons. Sears has been around for over a century, but with new accounting rules and changes in standards, it still must maintain the correct principles and the high standard it is held to.
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either give a more realistic number or explain in the notes why this number has changed so greatly (Sears 10Q Filing, 2003-09). To adjust for this anomaly we have taken the average of the two allowances for uncollectible accounts and inserted it, $992 into the balance sheet. This has reduced the total current assets to $17,235,000,000, which in turn reduced total assets to $26,762,000,000. Retained earnings were reduced to $10,675,000,000 and total shareholders equity became $5,440,000,000.
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Exhibit 1
SEARS ROEBUCK & CO 10-K 2004-01-03: Original Adjusted
Balance Sheet
2003/01/03 ASSETS Current assets Cash and cash equivalents Credit card receivables Less allowance for uncollectible accounts Net credit card receivables Other receivables Merchandise inventories, net Prepaid expenses and deferred charges Deferred income taxes Total current assets Property and equipment Land Buildings and improvements Furniture, fixtures and equipment Capitalized leases Gross property and equipment Less accumulated depreciation Total property and equipment, net Deferred income taxes Goodwill Tradenames and other intangible assets Other assets TOTAL ASSETS LIABILITIES Current liabilities Short-term borrowings Current portion of long-term debt and capitalized lease obligations Merchandise payables Income taxes payable Other liabilities Unearned revenues Other taxes Total current liabilities Long-term debt and capitalized lease obligations Pension and postretirement benefits Minority interest and other liabilities $1,956,000,000 $1,389,000,000 $1,956,000,000 $1,389,000,000 $3,106,000,000 $1,867,000,000 $2,950,000,000 $1,244,000,000 $609,000,000 $13,759,000,000 $4,218,000,000 $3,106,000,000 $1,867,000,000 $2,950,000,000 $1,244,000,000 $609,000,000 $13,759,000,000 $4,218,000,000 $1,033,000,000 $2,950,000,000 $1,033,000,000 $2,950,000,000 $392,000,000 $7,151,000,000 $4,972,000,000 $609,000,000 $13,124,000,000 $6,336,000,000 $6,788,000,000 $378,000,000 $943,000,000 $710,000,000 $708,000,000 $27,723,000,000 $392,000,000 $7,151,000,000 $4,972,000,000 $609,000,000 $13,124,000,000 $6,336,000,000 $6,788,000,000 $378,000,000 $943,000,000 $710,000,000 $708,000,000 $26,762,000,000 $9,057,000,000 $1,998,000,000 $31,000,000 $1,956,000,000 $733,000,000 $5,335,000,000 $407,000,000 $708,000,000 $18,196,000,000 $9,057,000,000 $1,998,000,000 $992,000,000 $1,956,000,000 $733,000,000 $5,335,000,000 $407,000,000 $708,000,000 $17,235,000,000 2003/01/03
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Total Liabilities COMMITMENTS AND CONTINGENT LIABILITIES SHAREHOLDERS EQUITY Common shares issued ($.75 par value per share, 1,000 shares authorized, 230.4 and 316.7 shares outstanding, respectively) Capital in excess of par value Retained earnings Treasury stock - at cost Deferred ESOP expense Accumulated other comprehensive loss Total Shareholders Equity TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
$21,322,000,000
$21,322,000,000
$323,000,000
$323,000,000
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Level I Ratios
Liquidity Ratios
12/31/03 12/31/02 12/31/01 12/31/00 12/31/99
Current Ratio (T) Quick Asset Ratio (T) Receivables Turnover (T) Inventory Turnover (T) Working Capital T/O (T)
Profitability Ratios
Gross Profit Margin (%) Operating Expense Ratio(%) Net Profit Margin (%) Asset Turnover (T) Return on Assets (%) Return on Equity (%)
Level II Ratios
12/31/03 12/31/02 12/31/01 12/31/00 12/31/99 Dividend Payout Ratio (%) SGR (%)
9.63 51.83
21.29 16.81
41.09 6.77
23.98 15
24.43 17
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3.33 in 2002 to 8.26% in 2003, and this is a very good indicator for the company. This shows that in 2003 Sears earned 4.93% more on each dollar of sales than in 2002. In other words, in 2003, 8.26 cents of every sales dollar was retained as profit, whereas only 3.33 cents of every sales dollar was retained as profit in 2002. Sears asset turnover increased from 2002 to 2003 {positive impact} after a decrease each year from 1999 to 2002 (negative impact). This increase in asset turnover shows that each dollar of assets produced 1.5 dollars of sales in 2003 compared to 83 cents in 2002. Sears return on assets has been increasing since 2001. It sharply increased from 4.85% in 2002 to 8.2% in 2003 (positive impact). This increase of return on assets ratio has been due to Sears high profit margins, and is also attributable to the improvement in asset turnover. The increase in net profit margin and asset turnover have caused Sears return on equity to increase, which is positive factor, from 11.49% in 2001 to 21.36% in 2002 and to 57.36% in 2003 Sears experienced a big decline in debt-to-equity in 2003 from 2002, which is a very good indicator for the company. It dropped from 6.46 in 2002 to 3.33 in 2003.The debt-to-equity ratio for 2003 indicates that the firm has 3.33 dollars of liabilities for every 1.00 dollar of owners equity, compared to 6.46 dollars of liabilities for every 1.00 dollar in 2002. This decrease indicates that debt has become a smaller proportion of total financing. The increase in times interest earned ratio from 0.86 in 2001 to 2.15 in 2002 and to 5.32 in 2003 indicates that Sears income from operations is more adequate to cover required interest charges. It jumped from 2.15 times in 2002 to 5.32 times in 2003. Level II Sears dividend payout ratio decreased from 41.09% in 2001 to 21.29% in 2002 and finally to 9.63% in 2003. We can say this is a negative impact for the company because companies with stable earnings are more likely to pay out a greater proportion of their earnings as dividends than are companies with more volatile earnings. However, companies with a large, continuing number of highreturn investment projects are less likely to pay out a high proportion of earnings 26
as dividends because of their need for the capital to finance these projects. As a matter of fact, Sears has expanded its stores in Canada and Puerto Rico the last 2 years, and just recently Sears bought a few discount stores from K-Mart. These expanding projects that Sears has undertaken the last years might have forced the company to cut its dividends. Sears sustainable growth rate (ROE * [1 Dividend payout ratio]) for the years 1999 2003 is as follows: 2003 51.83% 2002 16.81% 2001 6.77% 2000 15% 1999 17%
Sears sustainable growth rate declined from 1999 to 2001, and then it started to improve, noticeably from 2002 to 2003. Sears improved its sustainable growth rate because of its improved ROE (from 2001 to 2003) and a marginal decline in its dividend payout ratio (from 2001 to 2003). Sears & Roebuck vs. Competitors
Liquidity Ratios
5-Year Averages Current Ratio (T) Quick Asset Ratio (T) Receivables Turnover (T) Inventory Turnover (T) Working Capital T/O (T) Sears Wal-Mart JC-Penney Target
Profitability Ratios
5-Year Averages Gross Profit Margin (%) Operating Expense Ratio (%) Net Profit Margin (%)
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Comparison between Sears and Competitors: We are comparing Sears ratios with Wal-Marts, JC-Penneys, and Targets. They are Sears main competitors and the only ones that Sears competes in all divisions. We calculated the ratios for Sears and its competitors for each year from 1999 to 2003 and then we took the average of the 5 years in order to compare them with each other. Sears has a higher current ratio than Wal-Mart and Target but a lower one compared to JC-Penney. Sears has a current ratio of 1.97, which means that Sears must be able to convert each dollar of current assets into at least 0.5 dollars (1/1.97) of cash to meet short-term obligations. Sears competitors on the other hand must be able to convert each dollar of current assets into at least 1.2 dollars of cash (Wal-Mart), 0.43 dollars of cash (JC-Penney), and 0.6 dollars of cash (Target) to meet their short-term obligations. As a result Sears current ratio compares favorably with Wal-Mart and Target but not with JC-Penney. Sears quick ratio compares favorably with JC-Penney and Target but is unsatisfactory compared to Wal-Mart. The company has a quick ratio of 1.54, which shows that Sears current assets are equal to 154% of the current liabilities. On the other hand Sears competitors current assets are equal to 14% of the current liabilities for Wal-Mart, 158% of the current liabilities JC-Penney,
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and 77% of the current liabilities for Target. Sears days to receivables ratio is 196 days, which compares unfavorably with Wal-Marts 1.6 days, JC-Penneys 5.6 days, and Targets 0 days. Sears inventory turnover ratio compares favorably with JC-Penney and Target but not with Wal-Mart. This indicates that Sears has larger investment in inventory relative to the sales being generated compared to Wal-Mart, and a smaller investment in inventory compared to JC-Penney and Target. Sears asset turnover ratio of 1.1 compares favorably with JC-Penneys 1.02 and Targets 0.98 but is lower than Wal-Marts 2.6. This shows that each dollar of Sears assets produces 1.1 dollars of sales, compared to 1.02 dollars of sales for JC-Penney, 98 cents for target, and 2.6 dollars of sales for Wal-Mart. Sears gross profit margin of 33.55 is higher that its competitors gross profit margins (Wal-Mart: 21.94, JC-Penney: 33.03, Target: 31.25). This higher ratio indicates that either Sears pricing policies and/or its production methods are more effective than those of the competitors. Also, Sears net profit margin compares favorably with its competitors net profit margins. In other words, Sears is earning 0.65% more on each dollar of sales than Wal-Mart, 3.35% more than JC-Penney and 0.45% more than Target. Sears return on assets compares favorably with JC-Penney, and this is due Sears higher asset turnover compared to JC-Penney. However, Sears has a lower return on assets compared to Wal-Mart and Target because of its lower asset turnover compared to WalMart and Target. Sears has a higher return on equity ratio (26.51) compared to its competitors (Wal-Mart: 21.50, JC-Penney: 1.13, Target: 19.58). This is due to Sears higher profit margins, which have resulted in profitability ratios higher than its competitors. Sears debt to equity (4.98) is higher than its competitors debt to equity ratios. This indicates that Sears uses more than the usual amount of borrowed funds to finance its activities compared to its competitors. Sears times interest earned ratio (2.4 times) is less than its competitors ratio (Wal Mart: 15.85, JC Penney: 4.51; Target: 3.2). This shows that Sears competitors income from operations is more adequate to cover required interest charges than Sears. 29
Wal-Mart
20.14 19.72 20.68 21.42 21.94
Target
28.87 28.99 28.91 29.13 31.02
JC-Penney
30.02 28.42 27.3 25.08 32.06
Sears
34.07 35.89 33.82 32.31 31.68
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Wal-Mart
3.29 3.06 3.29 3.26 3.21
Target
3.77 3.43 3.43 3.39 3.41
JC-Penney
1.25 .31 -2.21 1.03 1.11
Sears
8.26 3.33 1.79 3.28 3.54
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Wal-Mart
10.47 9.66 10.24 12.10 11.19
Target
8.45 8.59 9.01 8.96 8.88
JC-Penney
3.81 1.95 -1.87 3.3 2.12
Sears
8.2 4.85 4.54 5.92 6.17
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Wal-Mart
15.02 13.77 14.64 18.05 17.65
Target
12.12 12.87 14.19 13.97 13.12
JC-Penney
5.62 3.23 -2.78 4.66 4.02
Sears
57.36 21.36 11.49 19.74 22.61
60 50 40 30 20 10 0 -10 1999 2000 2001 2002 2003 Wal-Mart Target JC-Penny Sears
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Wal-Mart
8.08 7.79 7.29 6.90 7.15
Target
6.52 6.27 6.29 6.33 6.31
JC-Penney
4.45 4.35 4.00 3.95 4.15
Sears
5.01 5.12 5.06 5.1 5.58
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Quick Ratio
Wal-Mart
.15 .15 .13 .12 .13
Target
.84 .61 .36 .35 .42
JC-Penney
.76 .79 .43 .53 .62
Sears
.85 1.81 1.92 1.48 1.63
2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 1999 2000 2001 2002 2003
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Current Ratio
Wal-Mart
.93 1.04 .92 .94 .96
Target
1.59 1.37 1.16 1.11 1.24
JC-Penney
2.01 1.93 1.71 1.90 1.97
Sears
1.32 2.15 2.32 1.95 2.09
2.5 2 1.5 1 0.5 0 1999 2000 2001 2002 2003 Wal-Mart Target JC-Penny Sears
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5-Year Averages
Current Ratio (T) Quick Asset Ratio (T) Receivables Turnover (T) Inventory Turnover (T) Working Capital T/O (T)
Profitability Ratios
5-Year Averages Gross Profit Margin (%) Operating Expense Ratio(%) Net Profit Margin (%) Asset Turnover (T) Return on Assets (%) Return on Equity (%)
33.55
25.4
Comparison between Sears and Retail Industry: Sears current ratio is 1.97 and this means that to satisfy the claims of shortterm creditors exclusively from existing current assets, Sears must be able to
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convert each dollar of current assets into at least 0.5 dollars of cash (1/1.97 = 0.50). The industry average for the current ratio is 1.22 times, meaning that the average firm in the retail industry must convert only 0.82 dollars (1/1.22 = 0.82) of each dollar of current assets in to cash to meet short-term obligations. Sears quick ratio is 1.54 times, which compares unfavorably to the industrys 0.4 times. This ratio shows that Sears current assets are equal to 154% of the current liabilities compared to 40% of the retail industry. Sears inventory turnover of 5.17 is unsatisfactory compared to the industrys 5.72. It takes Sears 70.6 days (365/5.17) to sell its entire inventory, whereas the retail industry only 63.81 days. Sears days to receivable ratio is 196 days (365/1.86). Because the industry average for this ratio is 63.8 days, Sears ratio is substantially above the average. Sears debt-to-equity is 4.98 times. Because the retail industry average is 1.79 times, Sears ratio indicates that the company uses more than the usual amount of borrowed funds to finance its activities. Specifically, it raises 4.98 dollars from creditors for each dollar invested by stockholders, which means that the companys debt suppliers have a lower margin of safety than is common in retail industry. Sears gross profit margin ratio is 33.55%, and is above the industrys 25.4%. This higher percentage indicates that Sears pricing policies and/or its production methods are more effective than the average company in retail industry. Sears net profit margin is 4.04%, which is higher than the industry average of 3.39% and is interpreted to mean that the company is earning 0.65% more on each dollar of sales than the average firm in retail industry. Sears return on equity is 26.51%, which is higher than the industrys 18.96%. The companys higher profit margins have resulted in profitability ratios superior to the industrys norms, even after the effects of debt financing are considered.
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Financial Statements Forecasting EXHIBIT AA Sears & Roebucks fiscal year ends on Dec 31st. We started our forecasting of financial statements (Income Statement, Balance Sheet and Statement of Cash Flows) by forecasting first the last quarter of 2004. Since Sears is not affected much by seasonality and since we didnt find any big financial fluctuations from normal operations in the first 3 quarters, to forecast Q4 we took the average of the first 3 quarters. To forecast Sears financial information, we computed the percentage change for each line in the financial statements by using Sears past financial statements information starting with fiscal year 1999 and ending with 2004 (See Exhibit A, B, C for past financial statements). We averaged the four values obtained in order to get an expected future percentage change. Then we multiplied this future percentage change by the forecasted 2004 financial statements information to obtain forecasted financial information for fiscal year 2005. The same approach was followed for most of the lines in financial statements to arrive at forecasted values for each fiscal year until 2013. The only lines we did not follow this straight-line percentage change method were the cash and equivalents line in the Balance Sheet and the income taxes line in the Income Statement. In 2003 Sears cash increased from 1,962 mill in 2002 to 9,057 mill, and this was due to the sale of the companys domestic credit sector. We didnt use the straight-line method because Sears balance of cash in 2003 deviates a lot from its balances in the previous years. And this high percentage increase from 2002 to 2003 would have caused our future cash and equivalents predictions not to grow by a smooth and normal growth. Also, we did not use the straight-line method to obtain Sears tax rate to compute its income taxes. Sears income tax rate ranged from 35.6% to 38.5% for the past 5 years. In fact, we took the average of the five income tax rates, which we found to be 37%, and then we multiplied that by each years forecasted pretax income in order to obtain net income for each year.
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Overall based on our ten-year forecast we found that Sears will perform at a steady growth rate. For example, we forecasted that sales would increase each year by 1.02%. We support this forecast not only because Sears sales have increased by 1.02% in average for the past 5 years but also due to the fact that Sears has started to expand its stores by acquiring 61 off-mall stores from KMart and Wall-Mart. And this has been due to the high demand of the services and brand name products that Sears offers. Sales increased by 1.29% during Q3 of 2003 and the first 2 quarters of 2004, which shows that consumers have responded favorably to the expanded product lineup of this one-stop shopping destination. We believe that this off-mall concept will progress well, and will be a major factor in Sears growth for the next 10 years. However, for two reasons we do not assume that our financial statements forecasts are free of errors and that our forecasts will be accurate for each year in the next decade. The first reason is that as past economic practices have dictated, the longer the time horizon the less accurate the forecasts will be. Second, future economic conditions might cause Sears not to perform as forecasted. For instance, an economic downturn might turn sears forecasted growth in sales the other way around, as people would want to save more money instead of to spend in buying Sears products and services.
Valuations Section
Introduction
This section shows the value of Sears Roebuck & Co. by taking risk into consideration, and calculating how much of the firm is financed by debt and equity. Discounted free cash flows, discounted dividends, discounted residual income, and abnormal growth earnings models are used in the following section to provide an intrinsic valuation of Sears Roebuck & Co. This section also values the company by using the retail industry averages and comparing the ratios of the company. The ratios used are price to earnings, price to book, dividend to
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price, and price to sales. These valuation methods will show the true value of Sears Roebuck & Co., and will also assess the risk involved with this company.
2004 (11/01/2004)
Sales (mill) Sears & Roebuck Wal - Mart Target J.C - Penney Industry Average:
W/O Trimming
EPS
2.75 2.4 2.15 2.15
BPS
28.3 10.75 14.35 18.75
DPS
0.92 0.48 0.3 0.5
PPS
34.8 53.8 50.39 34.78
P/E
22.44 23.44 16.18 20.69
P/B
5 3.51 1.86 3.46
D/P
0.0089 0.006 0.0143 0.0097
P/S
0.00019 0.001 0.0019 0.001
56.9 97.92
94.84 36.6
22.94 2.94 0.0075 0.0015
Industry Average:
With Trimming
63.08 83.2
122.66 54.9
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In the multiple valuation model we found that the method that came closest to the current market price ($34.8 as of 11/01/2004) of Sears Roebuck & Co. was the price-to-sales ratio. (See Exhibit 1) We believe this is the case because the value of the company is closely related to the amount of revenues in the retail industry. Sears Roebuck & Co. is priced at the level of performance they are currently operating at. The retail industry as a whole is priced according to their revenues, or sales. Even when the outlier was excluded price-to-sales ratio provided a price closer to the companys current price, even though the current price valued changed from $36.6 (w/o trimming) to $54.9 (with trimming). The sales used in our analysis were found using Edgarscan, and finding historical data from each companys income statement.
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The next valuation that must be done is WACC. Now that the Ke has been calculated we must solve for the other variables. The cost of debt (Kd) is calculated by using the balance sheet notes for 2003 to figure the weighted average of interest for Sears Roebuck & Co.s long-term debt. The average rate for short-term debt was also computed by taking the average of the commercial paper rates (6 month financial) for the past 60 months (October 1999 October 2004), which equals 3.76%. (See Exhibit 2) This is shown in the table below.
TTM 1-3 years 4-9 years 10+ years Sum of MV Long term debt rate Short term debt rate
7.57%
Weight of LT Debt
Cost of Debt (Kd) = (Avg. ST Debt * Weight ST Debt) + (Avg. LT Debt * Weight LT Debt)
Sears & Roebuck has a Z-Score of 5.97 (See Exhibit 2). This shows that Sears has a very good credit rating, which will allow Sears to obtain credit funds if needed. Also, this high Z-Score indicates that Sears will not face any state of distress for at least within the next year. This prime rating of Sears has been due to its strong financial performance. The value of debt (Vd) was computed by using the book value of liabilities from the balance sheet for 2004. This is found by adding short-term borrowings and long-term borrowings to find total liabilities:
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Vd = $1033 (million) + $4218 (million) = $5251 (million) The value of equity (Ve) was calculated by multiplying price per share (PPS) by shares outstanding: Ve = $27.78 * 230.4 (million) = $6401 (million) The value of the firm (Vf) is simply the sum of the value of debt (Vd) and the value of equity (Ve): Vf = $5251 (million) + $6401 (million) = $11,652 (million) Now with all of the components to WACC, we are able to calculate this model. The corporate tax rate for the firm was given at 31%. (See Exhibit 2) The following is the calculation: WACC = ($5251/$11,652) * (1-.31) * (.068) + ($6401/$11,652) * (.0949) = .0732
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estimated price per share deviates to $166.53 per share. This is in sharp contrast to the scenario in which WACC is increased by 2.23% and growth is decreased by 1%, which results in a price per share of $12.67. Sensitivity Analysis 0.0650 0.0250 0.0350 0.0450 38.5584 0.0732 0.0850 0.0950 WACC
52.7774 36.9408 23.2434 15.8358 81.2152 51.7236 30.4594 20.2652 82.7512 42.4861 26.9093
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Sensitivity Analysis 0.0849 0.015 44.748 0.0949 0.1049 0.1149 Ke 27.27 26.974 26.604 37.3288 31.6835 37.7786 31.6472
0.025 46.1116
Sensitivity Analysis 0.0849 0.015 54.7923 0.025 56.5927 0.0949 44.5106 0.1049 0.1149 Ke 37.264 31.9465
0.035 59.1147 46.4944 38.1358 32.2673 0.045 62.9009 Growth 48.0827 38.7899 32.4966
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Sensitivity Analysis 0.0667 0.015 25.496 0.025 29.919 0.0767 0.0867 0.0967 Ke 21.096 17.9363 15.56004 23.87 19.7937 16.8635
0.035 37.133 27.975 22.3697 18.58946 0.045 50.996 Growth 34.669 26.1812 20.98311
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In the abnormal growth earnings model our Ke proved to be a weakness because of the significant increase from 9.49% to 11.49%. We believe that our WACC valuation proved to be strong in comparison to our estimated growth rate and our Ke. The forecasted cash flows for Sears Roebuck & Co. are important in the estimation of the stock price using the discounted free cash flows valuation. We feel that the Discounted Dividends Model may be the least accurate of the three because it showed Sears to be overvalued, while all three of the other models showed Sears to be undervalued. If the Discounted Dividends Model is ignored, the price of Sears stock is undervalued by $5.82 per share.
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EXHIBIT AA Sears & Roebuck Forecasted Financial Values Income Statement; Balance Sheet; Statement of Cash Flows (Amounts in millions) INCOME STATEMENT YEAR Total Sales Cost of Goods Sold Gross Profit Operating Expense NIBIT Interest Expense Pretax Income Income Taxes (37%) NET INCOME 2004 36,600 23,954 12,646 7,956 4,690 1,225 3,465 1,282 2,183 2005 37,332 23,714 13,618 8,275 5,343 1,167 4,176 1,545 2,631 2006 38,078 23,477 14,601 8,605 5,996 1,111 4,885 1,807 3,078 2007 38,840 23243 15,597 8,949 6,648 1,059 5,589 2,068 3,521 2008 39,617 23,010 16,607 9,307 7,300 1,008 6,292 2,328 3,964 2009 40,409 22,789 17,620 9,680 7,940 961 6,979 2,582 4,397 2010 41,218 22,552 18,666 10,067 8,599 915 7,684 2,843 4,841 2011 42,041 22,327 19,714 10,470 9,244 871 8,373 3,098 5,275 2012 42,882 22,103 20,779 10,889 9,890 830 9,060 3,352 5,708 2013 43,740 21,882 21,858 11,324 10,534 790 9,744 3,605 6,139
BALANCE SHEET Year Cash & Equivalents Accounts Receivables Inventory Total Current Assets Accounts Payable Total Current Liabilities Working Capital Total Assets Total Liabilities Total Shareholder's Equity 2004 3,509 9,205 5,850 18,564 4,019 9,612 8,952 22,432 16,834 5,598 2005 4,210 8,100 5,932 18,242 3,506 9,107 9,135 21,748 16,329 5,419 2006 5,053 7,128 6,015 18,196 3,059 8,629 9,567 21,084 15,839 5,245 2007 6,063 6,272 6,099 18,434 2,669 8,176 10,258 20,441 15,364 5,077 2008 7,276 5,520 6,185 18,981 2,329 7,747 11,234 19,818 14,903 4,915 2009 8,731 4,858 6,271 19,860 2,031 7,340 12,520 19,213 14,456 4,757 2010 10,488 4,275 6,359 21,122 1,772 6,955 14,167 18,628 14,022 4,606 2011 12,573 3,762 6,448 22,783 1,546 6,590 16,193 18,059 13,601 4,458 2012 15,088 3,310 6,538 24,936 1,349 6,244 18,692 17,509 13,193 4,316 2013 18,105 2,913 6,630 27,648 1,177 5,916 21,732 16,975 12,798 4,177
Statement of Cash Flows Year CFFO CFFI Free Cash Flows 2004 2,612.33 1,989 623.33 2005 2,703.77 2,074.44 629.330 2006 2,798.40 2,164.55 633.850 2007 2,896.35 2,257.81 638.540 2008 2,997.72 2,354.33 643.390 2009 3,102.64 2,454.23 648.410 2010 3,211.23 2,557.63 653.600 2011 3,323.63 2,664.65 658.980 2012 3,439.95 2,775.41 664.540 2013 3,560.05 2,890.05 670.300
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EXHIBIT A
5 YR ANNUAL BALANCE SHEET Assets Cash & Equivalents Receivables Net Inventories Prepaid Expenses Other Current Assets Total Current Assets Long Term Receivables Investments in Unconsol Subsidiaries Other Investments Property, Plant & Equip - Gross Accumulated Depreciation Property, Plant & Equipment - Net Other Assets Total Assets (amounts in millions) 12/31/2003 12/31/2002 9,057.00 2,689.00 5,335.00 n/a 1,115.00 18,196.00 0 0 0 13,124.00 6,336.00 6,788.00 2,361.00 27,345.00 1,962.00 31,622.00 5,115.00 n/a 1,284.00 39,983.00 0 0 0 12,979.00 6,069.00 6,910.00 2,782.00 49,675.00 12/31/2001 1,064.00 28,813.00 4,912.00 n/a 1,316.00 36,105.00 0 0 0 13,137.00 6,313.00 6,824.00 973 43,902.00 7,176.00 6,714.00 n/a n/a n/a 1,694.00 15,584.00 18,921.00 1,732.00 n/a -415 n/a 0 35,822.00 0 1,961.00 n/a 6,119.00 43,902.00 12/31/2000 842 20,928.00 5,618.00 n/a 1,406.00 28,794.00 0 0 0 12,585.00 5,932.00 6,653.00 1,278.00 36,725.00 7,336.00 6,840.00 n/a 562 n/a 0 14,738.00 11,020.00 1,951.00 1,058.00 -174 n/a 0 28,593.00 0 1,363.00 0 6,769.00 36,725.00 12/31/1999 729 21,581.00 5,069.00 n/a 1,288.00 28,667.00 0 0 0 11,912.00 5,462.00 6,450.00 1,470.00 36,587.00 6,992.00 5,154.00 n/a n/a n/a 1,555.00 13,701.00 12,884.00 2,180.00 0 -367 n/a 0 28,398.00 0 1,350.00 0 6,839.00 36,587.00
Liabilities Accounts Payable 3,106.00 2,945.00 ST Debt & Current Portion Due LT Debt 3,983.00 9,333.00 Accrued Payroll n/a n/a Income Taxes Payable 1,867.00 787 Dividends Payable n/a n/a Other Current Liabilities 4,803.00 5,532.00 Total Current Liabilities 13,759.00 18,597.00 Long Term Debt 4,218.00 21,304.00 Provision For Risks And Charges 1,956.00 2,491.00 Deferred Income n/a n/a Deferred Taxes -378 -734 Deferred Tax Liability In Untaxed n/a n/a Reserves Other Liabilities 0 0 Total Liabilities 19,555.00 41,658.00 Shareholders' Equity Non-Equity Reserves 0 0 Minority Interest 1,389.00 1,264.00 Preferred Stock n/a n/a Common Equity 6,401.00 6,753.00 Total Liabilities & Shareholders' Equity 27,345.00 49,675.00 * Balance Sheet comes from Thomson One Business website
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INCOME STATEMENT
(Common Size)
YEAR Total Sales Cost of Goods Sold Gross Profit Operating Expense NIBIT Interest Expense Pretax Income Income Taxes 12/31/2003 100% 63.71% 36.2900% 26.63% 15.72% 2.50% 13.23% 4.88% 8.35% 12/31/2002 100% 62% 38.0000% 27.10% 8.64% 2.77% 5.88% 2.07% 3.81% 12/31/2001 100% 64.08% 35.9200% 24.92% 6.39% 3.47% 2.95% 1.14% 1.81% 12/31/2000 100% 65.67% 34.3300% 23.27% 8.48% 3.06% 5.43% 2.03% 3.40% 12/31/1999 100% 66.26% 33.7400% 22.62% 8.98% 3.10% 5.89% 2.20% 3.69%
NET INCOME
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EXHIBIT B
(amounts in millions) 5 YR ANNUAL INCOME STATEMENT Sales Cost of Goods Sold Depreciation, Depletion & Amortization Gross Income Selling, General & Admin Expenses Other Operating Expenses Total Operating Expenses Operating Income Extraordinary Credit - Pretax Extraordinary Charge - Pretax Non-Operating Interest Income Reserves - Inc(Dec) Pretax Equity Interest Earnings Other Income/Expense - Net Earnings Bef Interest & Taxes Interest Expense on Debt Interest Capitalized Pretax Income Income Taxes Minority Interest Equity Interest Earnings After Tax Other Income/Expense Discontinued Operations Net Income Bef Extraordinary Items & Disc Ops Preferred Dividends Extraordinary Items & Gain(Loss) Sale of Assets Net Income Bef Preferred Dividends 12/31/2003 41,124.00 26,202.00 909 14,013.00 10,951.00 0 38,062.00 3,062.00 93 932 0 0 0 4,243.00 6,466.00 1,027.00 2 5,441.00 2,007.00 45 8 0 0 3,397.00 0 0 3,397.00 12/31/2002 41,366.00 25,646.00 875 14,845.00 11,210.00 0 37,731.00 3,635.00 0 411 0 0 0 352 3,576.00 1,147.00 4 2,433.00 858 11 20 0 0 1,584.00 0 -208 1,376.00 12/31/2001 41,078.00 26,322.00 863 13,893.00 10,236.00 0 37,421.00 3,657.00 0 1,064.00 0 0 0 33 2,626.00 1,426.00 11 1,211.00 467 21 12 0 0 735 0 0 735 0 735 12/31/2000 40,937.00 26,885.00 826 13,226.00 9,526.00 0 37,237.00 3,700.00 0 265 0 0 0 36 3,471.00 1,252.00 4 2,223.00 831 49 0 0 0 1,343.00 0 0 1,343.00 0 1,343.00 12/31/1999 41,071.00 27,212.00 848 13,011.00 9,289.00 0 37,349.00 3,722.00 0 41 0 0 n/a 6 3,687.00 1,273.00 5 2,419.00 904 62 0 0 0 1,453.00 0 0 1,453.00 0 1,453
Preferred Dividend Requirements 0 0 Net Income Available To 3,397.00 1,376.00 Common * Balance Sheet comes from Thomson One Business website
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EXHIBIT C
(amounts in millions) 5 YEAR ANNUAL CASH FLOW STATEMENT Operating Activities Income Bef Extraordinary Items Depreciation, Depletion & Amortization Deferred Inc Taxes & Inv Tax Credit Other Cash Flow Funds From Operations Extraordinary Items Funds From/For Other Operating Acts Net Cash Flow From Operating Activities Investing Activities Capital Expenditures Additions To Other Assets Net Assets From Acquisitions Increase In Investments Decrease In Investments Disposal of Fixed Assets Other Use/(Source) - Investing Net Cash Flow From Investing Activities Financing Activities Net From Sales/Issue of Com/Prf Stock Com/Prf Purchased,Retired,Converted Long Term Borrowings Inc(Dec) In ST Borrowings Reduction In Long Term Debt Cash Dividends Paid - Total 3,397.00 909 648 -1,561.00 3,393.00 0 -869 2,524.00 1,584.00 875 -203 2,049.00 4,305.00 0 -4,810.00 -505 735 751 146 2,401.00 4,033.00 0 -1,771.00 2,262.00 1,343.00 826 26 1,208.00 3,403.00 0 -701 2,702.00 1,453.00 848 356 967 3,624.00 n/a 73 3,697.00 12/31/2003 12/31/2002 12/31/2001 12/31/2000 12/31/1999
Other Source/(Use) - Financing 2 11 Net Cash Flow From Financing Activities -16,212.00 3,721.00 * Balance Sheet comes from Thomson One Business website
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EXHIBIT 2
Excess Return Adjusted T-Bills Returns (Rm-Rf) Price
0.35% 0.38% 0.37% 0.38% 0.41% 0.43% 0.42% 0.45% 0.48% 0.47% 0.49% 0.48% 0.50% 0.50% 0.52% 0.55% 0.56% 0.54% 0.52% 0.56% 0.53% 0.52% 0.51% 0.49% 0.48% 0.48% 0.43% 0.41% 0.41% 0.39% 0.40% 0.41% 7.68% 5.53% 5.27% 3.72% -3.64% 3.45% 3.37% -2.95% 4.96% -3.68% -1.11% -3.34% 5.75% 1.41% 5.27% -5.64% -2.57% 9.13% -3.60% -2.75% 1.87% -2.15% 5.57% -5.84% -0.98% -8.48% -0.03% 3.06% -9.64% -6.81% 7.28% 0.10% 38.83 41.18 36.89 34.84 35.47 39.45 40.15 41.93 39.08 35.52 33.08 27.67 24.86 30.38 26.99 27.49 24.71 27.45 32.94 33.32 29.43 26.95 28.34 29.46 27.02 29.69 31.81 35.47 37.79 32.47 33.92 36.92 5.71% -11.63% -5.88% 1.78% 10.09% 1.74% 4.25% -7.29% -10.02% -7.38% -19.55% -11.30% 18.17% -12.56% 1.82% -11.25% 9.98% 16.67% 1.14% -13.22% -9.20% 4.90% 3.80% -9.03% 8.99% 6.66% 10.32% 6.14% -16.38% 4.27% 8.13%
DATE 19991030 19991130 19991231 20000129 20000226 20000331 20000430 20000528 20000630 20000730 20000831 20000930 20001029 20001130 20001231 20010131 20010229 20010331 20010428 20010531 20010630 20010731 20010831 20010929 20011031 20011130 20011229 20020131 20020228 20020330 20020430 20020531
Return
54
20020629 20020731 20020831 20020928 20021031 20021130 20021231 20030131 20030228 20030328 20030430 20030531 20030628 20030731 20030830 20030930 20031031 20031129 20031231 20040131 20040228 20040331 20040430 20040530 20040630 20040731 20040829 20040930 20041031
-2.50% -1.08% -6.41% -8.17% 1.81% 7.52% 0.76% -1.56% -2.08% 3.67% -6.14% -0.91% -7.25% -7.90% 0.49% -11.00% 8.64% 5.71% -6.03% -2.74% -1.70% 0.84% 8.10% 5.09% 1.13% 1.62% 1.79% -1.19% 5.50%
0.40% 0.40% 0.38% 0.34% 0.33% 0.33% 0.37% 0.36% 0.36% 0.40% 0.39% 0.37% 0.35% 0.32% 0.27% 0.25% 0.25% 0.25% 0.25% 0.25% 0.24% 0.23% 0.24% 0.21% 0.19% 0.24% 0.28% 0.27% 0.27%
-2.90% -1.47% -6.79% -8.52% 1.48% 7.19% 0.39% -1.92% -2.44% 3.28% -6.53% -1.28% -7.60% -8.22% 0.21% -11.25% 8.40% 5.45% -6.29% -3.00% -1.94% 0.60% 7.86% 4.88% 0.94% 1.38% 1.51% -1.46% 5.23%
39.17 43.49 39.78 32.24 36.08 42.57 44.56 49.43 49.39 48.16 49.55 55.7 51.22 44.49 43.14 36.97 24.9 26.49 22.9 25.29 21.05 23.34 27.39 29.2 32.77 39.64 43.11 42.83 51.54
5.74% 9.93% -9.33% -23.39% 10.64% 15.25% 4.47% 9.85% -0.08% -2.55% 2.81% 11.04% -8.75% -15.13% -3.13% -16.69% -48.47% 6.00% -15.68% 9.45% -20.14% 9.81% 14.79% 6.20% 10.89% 17.33% 8.05% -0.65% 16.90%
0.18% Intercept
-0.0008446
0.39% R^2
0.038576
-0.21% T-Test
0.489913
3.82%
55
9.49%
Commercial Paper (Financial) Date Oct-99 Nov-99 Dec-99 Jan-00 Feb-00 Mar-00 Apr-00 May-00 Jun-00 Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00 Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02
% Paid 5.09% 5.15% 5.04% 4.81% 4.82% 4.84% 4.80% 4.83% 5.04% 5.14% 5.28% 5.32% 5.93% 5.85% 5.93% 5.81% 5.90% 6.03% 6.15% 6.57% 6.59% 6.54% 6.49% 6.47% 6.52% 6.52% 6.33% 5.51% 5.19% 4.81% 4.47%
56
May-02 Jun-02 Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03 Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04
3.96% 3.69% 3.62% 3.44% 2.84% 2.29% 2.00% 1.81% 1.72% 1.80% 1.87% 1.83% 1.80% 1.78% 1.76% 1.71% 1.74% 1.71% 1.37% 1.32% 1.27% 1.25% 1.21% 1.23% 1.20% 1.02% 1.03% 1.06% 1.06% 1.06%
Sh-T Debt
TTM 1-3 years 4-9 years 10+ years Sum of MV L-T Debt Average 6.25% 9.38% 7.50%
3.76%
MV (mill.) 236 251 1838 2325 Percent 10.00% 10.00% 80.00% Wtd Avg 0.63% 0.94% 6.00%
7.57%
57
Cost of Debt = 6.8% Cost of Debt = 0.0376 * 0.198 + 0.0757 * 0.802 ZScore
WC/Total Assets Ret Earnings/TA EBIT/Total Assets MV Equity/BV Liab Sales/Total Assets 0.1622 0.426 0.236 2.44 1.5 1.2 1.4 3.3 0.6 1 1.946 0.6 0.78 1.14 1.5
ZScore
5.97
VE = PPS * # shares outstanding VE = 34.8 * 230.4 mill. VE (mill) = $6,401 VD = Book value of liabilities VD = 1,033 + 4,218 VD (mill) = $5,251 VF = VE + VD VF (mill) = $11,652 WACC=7.32% WACC = (Vd/Vf)*(1-T)*Kd + (Ve/Vf)*Ke T = 31%
58
2 2006
$2,798.40 ($2,164.55) 633.850
3 2007
$2,896.35 ($2,257.81) 638.540
4 2008
$2,997.72 ($2,354.33) 643.390
5 2009
$3,102.64 ($2,454.23) 648.410
6 2010
$3,211.23 ($2,557.63) 653.600
8 2012
$3,439.95 ($2,775.41) 664.540
9 2013
$3,560.35 ($2,890.05) 670.300 693.761
Sensitivity Analysis
13772.61 5251.00 8521.61
WACC
0.0450 0.0550
Growth
59
2 2006
33.22 4 0.96 36.26
3 2007
36.26 4.3 0.99 39.57
4 2008
39.57 4.5 1.02 43.05
5 2009
43.05 4.8 1.2 46.65
6 2010
46.65 5 1.4 50.25
7 2011
50.25 5.2 1.5 53.95
8 2012
53.95 5.4 1.6 57.75
9 2013
57.75 6 1.6 62.15
BV Equity (per share) 2003 Total PV of RI (end 2003) PV of Terminal Value (end 2003) 0.538/(.0949-0.035) * 0.442 Estimated Value per Share 12-3104 Estimated Value per Share 11-0104 Actual Price per Share ($)
30.36 4.09939
3.969629
Sensitivity Analysis
0.0849 0.0949 37.3288 37.7786 38.3786 39.219 0.1049 31.6835 31.6472 31.6006 31.5383 0.1149 27.27 26.974 26.604 26.1281
Ke
Growth
60
2004 EPS DPS DPS invested at 9.49% Cum-Dividend Earnings (EPS + DRIP) Normal Earnings [EPS * (1+ Ke)] Abnormal Earning Growth (AEG) (Cum Div - Normal EPS) PV of AEG EPS 2004 Total PV of AEG PV of Terminal Value Total PV of AEG + EPS 2004 Capitalization Rate (perpetuity) Estimated Value per Share 12-3104 (4.418 / 0.0949) Estimated Value per Share 11-0104 46.56/(1+Ke/12^(2/12)) Actual Price per Share ($)
3.5 0.164998 0.753 3.5 0.92
2 2006
4 0.96 0.089206 4.089206 4.16062
3 2007
4.3 0.99 0.091104 4.391104 4.3796
4 2008
4.5 1.02 0.093951 4.593951 4.70807
5 2009
4.8 1.2 0.096798 4.896798 4.92705
6 2010
5 1.4 0.11388 5.11388 5.25552
7 2011
5.2 1.5 0.13286 5.33286 5.4745
8 2012
5.4 1.6 0.14235 5.54235 5.69348 0.15113
9 2013
6 1.6 0.15184 6.15184 5.91246
0.055158
-0.07141
0.011504
-0.11412
-0.03025
-0.14164
-0.14164
0.23938
0.102014
0.050377
0.008764
0.10585656
Sensitivity Analysis
4.418
0.0949
Ke
46.56
0.035 0.045
46.49 34.78
Growth 61
0.035 6 2010
Ke(new) = 7 2011
1 2005
2 2006
3 2007
4 2008
5 2009
28 27.97 34.78
0.015 0.025 0.035 0.045
Sensity Analysis
0.0667 25.496 29.919 37.133 50.996 0.0767 21.096 23.87 27.975 34.669 0.0867 17.9363 19.7937 22.3697 26.1812 0.0967 15.56004 16.8635 18.58946 20.98311
Ke
Growth
62
Bibliography Sources
o Halligan, Cathy. (2002, July 9). Will Sears Be More Like Target Than Kmart? http://www.marketingprofs.com/2/prophet3.asp o Hoover's. (2002). Lands' End. Austin, TX: Hoover's Inc. o Multex Investor. (2003). Sears, Roebuck & Co. Profile. from Reuters Research Inc http://businessmajors.about.com/gi/dynamic/offsite.htm?site=http://biz.yahoo. com/p/s/s.html o Prentice-Hall. (2003). Can Sears Reinvent Itself? http://wps.prenhall.com/bp_laudon_essmis_5/0,,155336-,00.html o Scheraga, Dan. (2002, July). Lands' End lends a hand: Sears' direct marketing will get a boost
from newly acquired know-how. Chain Store Age Executive with Shopping Center Age 78(7), 58(1).
o o o
o Sears Roebuck & Co. 2003 10K Filing o Sears Roebuck & Co. 2003-09 10Q Filing o Sears Roebuck & Co. 2004-07 10Q Filing o http://biz.yahoo.com/e/031105/s10q.html
o https://us.etrade.com/e/t/invest/performance?sym=S&pr od=S:NYSE:EQ o Thomson One Analytical Business o Morningstar.com o Sears Roebuck & CO 10K 2000-12-30 Income Statement o Sears Roebuck & CO 10-K 2004-01-03 Income Statement
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