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These Hardware Spin-Offs Went In Opposite Directions

Wednesday - 4/17/2013, 5:39pm  ET

Over the past two years, Chicago-based retail icon Sears Holdings Corporation has executed two highly publicized spin-offs of non-core businesses. In 2011, the company spun off a California-based subsidiary that maintains a chain of Home Depot-style home improvement stores. Known as Orchard Supply Hardware Stores Corporation , this firm has struggled to differentiate itself in a very crowded market for home improvement services. 

In late 2012, it spun off another chain of home improvement and hardware stores known as Sears Hometown & Outlet Stores . This gambit has paid off much better for Sears' shareholders.

Since both of these spun-off subsidiaries engage in similar businesses and fight with similar competitors, it may not make sense for investors to hold positions in both companies. As such, it might behoove growth-minded market-watchers to delve into both companies' financial statements and post-spin performances to determine if one offers a clear advantage over the other. 

Sears Holdings Corporation is a diversified retail giant with many brands that consumers love. Sears Hometown and Orchard Supply Hardware are less known, however. Sears Hometown & Outlet Stores is a chain of home improvement stores that primarily operates in North America. The company caters to residential customers with gardening supplies, tools, landscaping equipment and other home improvement products. Since the spin-off, it has demonstrated solid financial performance. Financially speaking, it offers a return on equity of about 11 percent and quarterly earnings growth north of 22 percent. Sears Hometown & Outlet earned about $60 million on $2.5 billion gross revenues in 2012.

Orchard Supply Hardware Stores Corporation, on the other hand, offers a shockingly poor return on equity of negative 196 percent and shows quarterly revenue growth of negative 2 percent. In 2012, it lost $92 million on $645.8 million gross revenues. Its operations are exclusive to California and mirror those of its fellow Sears spin-off, include gardening services and power equipment sales. The company also sells to commercial customers like contractors, home builders and professional landscapers.

Sears Hometown's Post-Spin Performance

Since its mid-October spin-off, Sears Hometown's share price has risen from its offering price near $30 to its current price of about $40. This represents a gain of about 33 percent in less than six months. 

Sears Hometown's stock has climbed as high as $46 per share and fallen as low as $29.50 per share; however, it has not traded below $32 per share since the start of 2013. With multiple levels of support between its current price and its offering price, it seems unlikely to correct back to its immediate post-spin levels. Although its most recent quarterly earnings report left something to be desired, relatively few market-watchers expect this company's financial situation to deteriorate markedly in the short term. In addition, its P/E ratio of 15.3 is not particularly high relative to its peers. As such, Sears Hometown looks like a fairly stable investment for risk-averse traders.

Orchard Supply's Post-Spin Performance

Orchard Supply has not had such good fortune. In fact the company's post-spin performance has been punctuated by a series of disappointments that have collectively drained its stock of more than 85 percent of its initial value. From an initial level of about $25 per share, Orchard's stock briefly rose to touch $27.50 before beginning a nearly uninterrupted decline to its current share price of about $3.80. 

Orchard's management team is no longer trying to sugar-coat this situation. The company has announced plans to reinforce its balance sheet and may begin to raise additional capital in the coming months.

Which Is the Better Buy?

With a market capitalization of just $23 million, Orchard's valuation seems low even for a struggling company. After all, the value of its physical assets exceeds its market capitalization by a significant margin. That being said, Orchard has more than $10 of debt for every $1 in cash on its balance sheet and cannot seem to grow its sales despite an improving housing market in California.

Even if Orchard's stock is somewhat undervalued, its high beta of 2.82 should give conservative investors pause. Those who cannot stomach violent price swings have no business owning such a historically volatile stock. Then again, Sears Hometown is even more volatile--despite its steady price appreciation, the company's beta value is nearly 5.1. 

It seems clear that Sears Hometown offers a better value for conservative investors. If it continues to grow its sales over time, it may well initiate a dividend or begin a program of share buybacks that could boost its value even further. By contrast, Orchard Supply seems likely to remain adrift for the foreseeable future. For other investment ideas regarding spinoffs, click here.

This article was originally published as These Hardware Spin-Offs Went In Opposite Directionson

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