'Dumpster-Diving' for Value in Shares of Sears Hometown

One of my all-time favorite stock screens is in a slump, producing little in the way of investable ideas. In fact, I've never seen the cupboard this bare, as it applies to the identification of net/nets, or companies trading below their net current asset value (NCAV).

As I wrote last week regarding LeapFrog (LF), there are only a handful of net/nets with market caps in excess of $100 million. Slim pickings to say the least, and the worst environment for deep value's version of "Dumpster diving" in the 20 or so years I've been a net/net aficionado.

Sears Hometown and Outlet Stores (SHOS) makes the cut. The struggling appliance retailer, which has a fairly large presence with nearly 1,250 stores, trades at just under two-thirds of NCAV, which meets Ben Graham's fundamental definition of a net/net, although I doubt old Ben would take a chance on this one.

Routinely hated or ignored by Wall Street, revenues have been falling, and the company was in the red last year. The past two quarters have been marginally profitable, but not enough to excite anyone. In fact, this company has fallen off the radar so much that it currently garners no analyst coverage.

The company currently trades at less than 0.43x tangible book value per share, but the quality of assets in not strong. While there's $23 million in cash on the books, the bulk of net current assets is comprised of inventory ($431.4 million), which is not uncommon in these situations. There's $102 million debt, of which $92 million is payable to the mother ship, Sears Holdings (SHLD), which spun off SHOS in 2012. It's been downhill ever since. Shares topped out above $55 in May 2013 and now can be had for about $8. The question is whether there's any life left in this name.

Down-and-out retailers are fairly common as net/nets. There are great success stories, and others that ultimately failed. Regional electronics retailer Conn's (CONN) was a net/net back in 2010, trading in the $3 range, and a rather ugly story at the time, as net/nets usually are. Shares topped out at about $79, making it a 25 bagger less than three years later, before settling to the current $24 range.

Others net/net retailers have been the veritable "cigar butt with one puff left." Back in early 2003, Circuit City graced the list of net/nets. By the following year, the stock had risen more than 150%. The comeback was fleeting, however, and the electronics retailer ultimately went under in 2009.

The path that Sears Hometown will take remains to be seen. It is currently priced as though there is little future for the company. If it can demonstrate even a small turnaround, shares could pop. A below-NCAV valuation is so extreme that it can provide a great deal of leverage -- option-like in some cases-- that any good news could be a big catalyst. The company is expected to report third-quarter earnings in early December, which should give us some insight as to whether the company may have the ability to turn the corner.

Net/nets, particularly retail net/nets, are not for the faint of heart.

Have a wonderful Thanksgiving!

Please note that due to factors including low market capitalization and/or insufficient public float, we consider SHOS to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Heller had no positions in the stocks mentioned.