April 2, 2004

Sears Canada released its year-end financial results on January 29, after first downgrading and then upgrading its earnings guidance within the span of a month. Excluding non-comparable items, Sears earned $1.32 per share in fiscal 2003 compared to $1.30 per share the previous year. These results were nicely above previously lowered earnings guidance of $1.10 to $1.20 per share. However, the results did demonstrate the tough conditions facing Canadian retailers, as total revenue decreased 4.8% to $6.223 billion and same store sales declined 4.6%. On a positive note, expense control and inventory management led to an improvement in the gross margin of 40 basis points.

In other news, Sears Canada recently exited the auto service business, by closing several locations and licensing the operation of others to three separate tire retailers. By exiting this non-core business, Sears can continue to focus its efforts and capital on off-mall or power center locations. Further, the elimination of non-core assets would theoretically allow Sears Roebuck to make a "cleaner" take-out of its Canadian subsidiary. Not to speculate, but we have seen at least two sell-side reports suggesting that a takeout offer would make sense from a timing, strategic and financial standpoint. Sears Roebuck is well aware that the sum-of-the-parts is worth more than the whole, as we highlighted in our previous comment on Sears Canada.

September 10, 2004

Since our last comment on Sears Canada, the retailer has reported results for the first half of fiscal 2004. In the first quarter, Sears earned $0.09 per share, before unusual items, on revenue of $1.331 billion. Same store sales increased an impressive 8.1%, driven by sales of major appliances, furniture, cosmetics, jewelry and children’s wear. In the second quarter of the year, Sears earned $0.11 per share, before unusual items, on revenue of $1.487 billion. Same store sales increased 1.4%. The increase in same store sales was below the pace set in the first quarter as unseasonably cool weather hindered sales of seasonal items such as air conditioners, patio furniture, outdoor grills and apparel. These results demonstrate just how sensitive retailers are to the variability of the Canadian climate. However, management reiterated its guidance of mid-teen earnings growth for the full year in the second quarter press release.

We are still comfortable with our rationale for owning the stock and believe that Sears Canada is a sum of the parts story. The market continues to ignore various assets such as the Company’s trucking division, credit card operations, banking services and real estate holdings. With the stock trading below book value of $17.08, the potential for Sears Roebuck to make an offer for its Canadian subsidiary exists. Interestingly, on August 26, Sears Canada announced that the contract of Chairman and CEO Mark Cohen had been terminated “as a result of strategic differences over the future direction of the business”. Glenn Richter, Executive Vice President and Chief Financial Officer of Sears Roebuck, was named Chairman of the Sears Canada Board. We plan to wait patiently for either the valuation to improve or a value-creation scenario to play out.

November 19, 2004

This past Wednesday, Kmart Holding Corporation and Sears, Roebuck and Co. (the parent company of Sears Canada) announced a definitive merger agreement. The new entity, Sears Holdings Corporation, will become the third largest retailer in the United States, with approximately US $55 billion in revenue. News of the US $11 billion deal sent shares of Sears, Roebuck 17% higher on the day, up US $7.79 per share.

Strategically, the deal will leverage Kmart’s reputation for low prices and Sears’ reputation for customer service and hardline goods. Sears, Roebuck will also have access to Martha Stewart Everyday products, which are currently sold through Kmart in the United States and Sears Canada in Canada. Management expects that the combination will generate US $500 million of annualized cost and revenue synergies within 3 years.

However, the value of the retail operations may not have been the primary driver of this transaction. Edward Lampert, Kmart’s Chairman, recognized the hidden value of Sears, Roebuck’s extensive real estate holdings. In fact, when it was announced in early November that Vornado Realty Trust had taken a 4.3% stake in Sears, Roebuck, the shares rallied 23%. We believe that this validates our view that the market not only fails to incorporate all relevant information but that a catalyst can materialize unexpectedly and surprisingly quickly.

So what does this mean for Sears, Roebuck’s 54% stake in Sears Canada? Apparently not much according to a Sears Canada spokesman who said, “The ownership hasn’t changed and we’ve been given no indication that it will. The news for Sears Canada is really there is no change for us”. This did not stop approximately 1.2 million shares of Sears Canada from trading on Wednesday, taking the stock up 6% or $1.07 per share. Although the shares have since pulled back from their highs, we continue to believe that Sears Canada trades below the value of the sum of its parts. Hopefully the shares will continue to move closer to the intrinsic value of the Company, with or without a catalyst.

January 28, 2005

Yesterday, Sears Canada reported results for its all-important fourth quarter and for the 2004 fiscal year. The results, like those of all retailers, were impacted by a calendar anomaly. Not only was this quarter one week shorter than last year, Christmas fell on a Saturday, which eliminated an extremely busy shopping day. Revenues for the 13-week period were $1.915 billion compared to $2.039 billion in the 14-week period last year, a decrease of 6.1%. The Company estimated that the extra week in 2003 represented $140 million in sales. For the full year, sales reached $6.230 billion compared to $6.223 billion the previous year. On a comparable week basis, same store sales declined 1.7% for the quarter but increased 1.6% for the year.

Despite the sales decline, management tried to avoid discounting and excessive promotional activity and the gross margin declined only 85 basis points in the quarter. Net earnings, excluding non-comparable items, were $92.4 million or $0.87 compared to $102.6 million or $0.96 per share last year. For the year, earning per share excluding non-comparable items were $1.25 versus $1.32 in 2003. Most analysts on the street were expecting lower margins and earnings, so the market was generally pleased with these results. Inventories declined 1.4% year over year as management cleared out last season’s merchandise to freshen the product offering. Expenses remained well under control and declined 4.6% with a net reduction in staff and various productivity improvements.

Our investment thesis has always been less focused on quarterly performance and more on a sum of the parts valuation. The Company’s SLH Transport division, real estate, credit card operations or even Sears Travel could be monetized to create shareholder value. Another possible catalyst for Sears would be consolidation within the department store sector. With the merger of Kmart and Sears, Roebuck, speculation regarding a merger between Federated and May Department Stores and the aggressive American investor Jerry Zucker taking an interest in Hudson’s Bay we believe that the North American department store landscape is ripe for further change. Although the probability of Sears Roebuck taking in the whole Company may be low in the short-term, we believe that such a move would make strong strategic and financial sense. As always, value investors will simply have to wait patiently for the story to play itself out.

February 25, 2005

We have long promoted the idea that Sears Canada should be viewed as a sum of the parts story as opposed to an earnings story. With assets such as valuable real estate, profitable credit cards, Sears Canada Bank and SLH Transport we believed that the net asset value was somewhere above $20 per share. We also pointed to the possibility of Sears Roebuck taking out the entire Company if the valuation remained depressed. However, it took a strongly worded research report from a highly respected Bay Street analyst to drive the share price from $17 to over $21 in just a few short weeks.

However, we don’t believe that a takeout is imminent for several reasons. In the United States, shareholders will be voting on the merger of Kmart and Sears Roebuck on March 24. Although we expect that the deal will be approved, we believe that the combined entity, Sears Holdings Corporation, will be more focused on the challenges of integration than on making an offer for Sears Canada in the near term. Hudson’s Bay is facing its own challenges and recently lowered earnings guidance, which points to the generally weak retail environment for Canadian department stores. Because Sears Canada spiked so dramatically, we believe that Sears Holdings Corporation will be patient and disciplined with its capital. With speculation by retail, institutional and hedge fund investors driving the story, we believe that it is prudent to take our profits now. We have sold our entire position in Sears Canada and are looking to use the proceeds to purchase cheaper US-based retailers.