Invest in cash-rich, growing businesses with a strong competitive position. It's nearly fail-safe investment advice.
Except, perhaps, when the stock in question has another defining characteristic: a controlling shareholder that seems to be exercising an unusual amount of control.
How else can we explain Sears Canada and its ever-growing cash hoard, deployed in neither reinvestment in the business, nor a shareholder-friendly dividend or buyback.
Colin Stewart of JC Clark would certainly like an explanation. His firm has been a Sears Canada shareholder since 2003, attracted by the company's franchise in the post-Eaton's era. JC Clark has been rewarded with a nice return so far, including a $17 special dividend/return of capital in 2005.
It could be better, Mr. Stewart believes, given current prices and valuations, particularly in comparison to its U.S.-based controlling shareholder, Sears Holdings Corp.
At the recent price of $29, Sears Canada trades for an enterprise value-to-EBITDA multiple of 4.2, Mr. Stewart says. At the recent price of $108 (U.S.), Sears Holdings trades at a 7.3 multiple in the same metric. Price-to-free cash flow? 7.1 for Sears Canada; 18.5 for Sears Holdings.
What's getting Mr. Stewart worked up is what he sees as Sears Canada's ineffectual balance sheet. At Jan. 30, Sears Canada had nearly $1.4-billion (Canadian) in cash, or $12.99 per share. Net of debt, cash represents $9.58 per share of value.
Mr. Stewart notes the cash sits, unused, invested in low-yielding short-term securities. His point: If Sears Canada isn't going to reinvest the money back into the business, give shareholders a chance to invest it themselves, preferably through a dividend.
With recurring annual free cash flow in the $280-million to $300-million range, Mr. Stewart argues, Sears Canada could pay out just 60 per cent and provide a dividend in the ballpark of $1.60 per share. That's a yield of more than 5 per cent on recent prices.
Mr. Stewart, whose firms own several hundred thousand shares, would like to communicate this idea directly to management, but he's had difficulty getting face time. He attributes that to the corporate culture at Sears Canada since American hedge fund manager Edward Lampert took control of Sears Holdings in 2005.
Attempts to reach Sears Holdings were unsuccessful, but Sears Canada spokesman Vincent Power said the Canadian board is operating in the best interests of its shareholders. "Those independent board members are there for a reason," Mr. Power said.
Mr. Stewart began writing letters to the Sears Canada board and management team last fall expressing his concerns about the cash pile. General Counsel Klaudio Leshnjani told Mr. Stewart, "Given the very uncertain economic times in which we live, our view has been that having a cash cushion is very much in the company's best interests."
The back and forth culminated in a November meeting with two of Sears Canada's independent directors, where, Mr. Stewart said, they frequently responded "no comment" on advice of counsel. Sears Canada management declined a meeting because it believed it "could … be seen as illegal selective disclosure."
So Mr. Stewart says he plans to attend Friday's shareholder meeting and ask as many questions of management as he's allowed. Mr. Power on Thursday reiterated the company's concerns about selective disclosure and said, "With the economy still in recession and high unemployment, the board believes it's prudent to maintain a low level of debt and high levels of cash."
Strange, it seems, but perhaps a bit of history is in order. Sears Holdings, which now owns 73 per cent of Sears Canada, made a run at taking the Canadian concern private at $18 per share in 2006. That effort collapsed after a series of legal squabbles and regulatory intervention.
It was thought that Mr. Lampert would be back in the not-too-distant future with another bid. But it's been more than three years, and all Sears Holdings has done is chip away at Sears Canada's public float by buying out impatient shareholders, a few hundred thousand shares at a time.
That's left just a hardy little bunch in the minority, playing this waiting game. Bill Ackerman of Pershing Square Management, the chief obstacle to the last going-private transaction, owns 17.3 per cent of Sears Canada. That means JC Clark and its fellow shareholders own less than 10 per cent of the company.
The curious result of these numbers is that a dividend would overwhelmingly benefit Lampert's Sears Holdings. Under Mr. Stewart's hypothetical scenario, roughly $125-million of a $175-million annual dividend would head back to headquarters in Hoffman Estates, Ill.
Better yet, Sears Holdings likely wouldn't have to pay tax on the payout. U.S. tax analyst Robert Willens notes that in this situation, Sears Holdings would be deemed to have paid a portion of Sears Canada's taxes. These "deemed taxes" then can be used as a credit against the U.S. tax attributable to the dividend.
It's hard to imagine what the holdup could be on sending this cash out to shareholders. Unless, of course, Sears Holdings foresees a situation when it owns 100 per cent of the shares, not 73 per cent, and can get 100 per cent of the cash, dividend or no. That suggests some sort of takeover premium which could further reward JC Clark and other minority shareholders - if they have the patience to keep watching all that cash stagnantly pile up.