Aas you can tell, price per square foot data can vary quite significantly. Not all square footage is created equal and, ultimately, it’s how you monetize your square footage which really matters. In the case of Sears, though they own a significant amount of retail square footage, the majority is leased to its own businesses which have performed in lackluster fashion to say the least. Despite this, there has to be some assumption of inherent value in the square footage. (This is something I ignored when I made the statement that Sears’ sales declines and lack of investment in its stores was an unsustainable business model.)

The Company’s 10K is a bit opaque as far as square footage controlled. From the information available, I pieced together that the Company is in control of something like 267 million square feet of retail space. However, it only owns 814 of 3,918 stores and classifies 1,061 stores as “independently owned and operated.” Assuming that the Company could only exercise “REIT-like” control over these stores, it’s “REIT valuable” square footage is probably closer to somethign like 100-125 million square feet. At the median price to square foot value above ($35.71 per square feet), we would find the owned real estate of the Sears business valued around $4 billion and, at the average price ($49.44 per square feet), a hypothetical Sears REIT should be worth $5-$6 billion.

Sears is currently trading at $7.9 billion in market cap. The above analysis is admittedly rough and back of the envelope, but it does lend some credence to the idea that Sears is very conservatively valued (possibly undervalued) by the market. Even if my argument that the Sears retail business is unsustainable is true and we were to ascribe zero value to Sears and Kmart retail (a horrible over simplification), the value of the Kenmore, Craftsman, Lands End and various other brands is likely worth at least $1-$2 billion (Sears holds tradenames and intangibles on the books at $3.3 billion). This ascribes an overall value to the business around $6-8 billion in the most draconian of cases.

As long as Sears and KMart underperform and as long as market value for the stock stays at or below this baseline valuation, it does make a significant case for management to spend money buying back stock and otherwise operating to realize value from the real estate as opposed to throwing money at capex to turn around the standard retail business. The question is, with two retail behemoths the likes of KMart and Sears, how exactly can management catalyze the realization of the underlying “REIT” value in the Company’s real estate? And, can this happen in a timeframe quick enough to provide adequate return to investors who might be thinking about going long on SHLD today?

If any out there in the community have more insight on Sears’ real estate holdings and its potential valuation as a REIT, do feel free to chime in. I admit my analysis is cursory at best, but I think it’s directionally correct and does beg further analysis as SHLD is beginning to look like a more compelling stock despite its retail businesses’ poor operating performance.

Full Disclosure: No positions in SHLD at the time of writing.

A colleague of mine recently brought an interesting phenomenon to my attention. REITs and one particular REIT – Simon Property Group (SPG) – have had quite the run in the last few months. The above chart runs from March until today – June 22, 2009. It’s clear to see that REITs as an asset class (using VNQ as a proxy) have rallied in excess of the broad market. Simon Property Group – a REIT specializing in malls and outlet centers – has rallied even in excess of the REIT class in general (almost 75%)!  With the S&P 500 (and likely the broader market in general) now showing weakness, could SPG be vulnerable to a precipitous fall?

It would seem that the increased interest in the REIT asset class and, in particular,  premium names such as SPG has been driven mostly by institutional reallocations to real estate at the beginning of the year. This has allowed many REITs to recapitalize and assuage investor fears of potential liquidity issues within the sector. With beginning of the year reallocations set and the market seemingly poised to correct, demand for REIT stocks could face pressure.

Simon Property Group Valuation

The traditional metric for REIT stocks is Price to Funds from Operations (FFO) which is a simple adjustment to net income to better approximate true operational profits by adding back depreciation and amortization expenses. We find that SPG is trading slightly above peers in this category. Further, its trading multiple has increased significantly since the end of 2008.

On a price-to-EBITDA basis, SPG is also trading roughly in line with peers, but still below levels at the end of 2008 despite the overall economic outlook firming up in the last few months.

On a price to square foot basis, the market is once again valuing SPG at a premium to other retail oriented REITs. Seems to me that we have a trend here.

Could SPG be in for a larger correction?

Last but not least, let’s take a look at how SPG compares to its peers. For one thing, SPG is larger than most of its competitors. Second, it’s more conservatively levered than most of its peers. And, finally, it squeezes more earnings per square foot out of its properties than most of its competitors. It would seem that Simon is at least somewhat deserving of its current above average valuation, but it’s hard to say the  extent to which this is reasonable. It would seem that at least in the near term, SPG is a good candidate for a short term correction.

Full disclosure: Author has no positions in the stocks mentioned at the time of writing.

I don’t make a lot of my purchase and sale decisions based on broad market technical analysis, but I do believe that it can be somewhat helpful in trying time your asset allocation decisions.

Taking a look at the above year-to-date chart for the S&P 500, we see signs of what seems to be a profound reversal in trend. The index bounced powerfully off March lows to trade back across its 50-day moving average. At this point, the uptrend decelerated but continued in expected fashion until closing today.

Interestingly enough, today’s close and likely subsequent moves in the stock market will signal several technically significant tests of trend. The green trendline above represents the near term trend, breaching this support is less significant to long term investors, but could signal a deceleration in the pace of the stock market’s recent rebound. As there is no obvious new high, higher low which connects our last low to current interim highs, it’s difficult to say for sure where long term support ought to hold.

Without the benefit of a long term continuum, the only clear indications of support and resistance can be found using the 50-day and 200-day moving averages. In my opinion, the recent cross above the 200-day moving average is decidedly premature as the 200-day moving average has not yet inflected to form a right-side trend (upwards). Instead, true support is probably somewhere closer to the 50-day moving average, though it is fast approaching a potential bullish cross.

What does this all mean? Well, it seems we’re at a “crossroads” in market sentiment. The appreciation in the market since the brief pullback in May has been on lower volume and lower relative strength as well as an increasingly bearish looking cross in MACD. The implication here is that for the last month we’ve been the beneficiaries of residual overbuying likely to give way to selling pressure at some point.

Will the market eventually crack down? It’s hard to say, but it would seem that at least in the short term, the S&P 500 is vulnerable to shock. The real question is whether or not support will hold. A prudent investor would likely have been taking the opportunity to lock in gains and improve his cash balance so as to capitalize on opportunities when a correction eventually takes hold. Unlike the swift and relentless pullback we experienced in September and October of last year, technical indicators have provided more than adequate warning of a potential downturn in broad market action.

A lot has been written since about how CEO Bill Klesse and Valero management has mismanaged the business and how this company deserves its well below industry average P/E ratio.  The all-knowing Jim Cramer even put Bill on the “Wall of Shame.” Is this all an over reaction or was I wrong about my purchase of Valero earlier in the year? Is Valero not truly a value, but a dreaded value trap?

One positive note with regards to last week’s bomb was that Valero was able to issue shares to the market at $18, establishing a relatively acceptable floor for share value relative to its lows for the year.

The decision to issue shares at $18 per share is, however, a pretty damning data point. Management has bought back nearly $9 billion of shares over the last three years at prices near $60 per share and this most recent offering is all but an admittance that they mismanaged their capital allocations. That being said, a year ago, these moves were being lauded as shareholder friendly and the right way to return value to shareholders. At the very least, we know that management has in the past been shareholder friendly (probably to a fault) during flush times.

As far as operations go, the fact that Valero has managed to lose money due in part to downtime at refining facilities as well as lagging demand for diesel and poor sour crude margins this quarter is worrisome. This will require closer attention going forward, particularly if other refiners show an ability to turn profits over the last quarter. My original thesis on refining was that refined product demand ought to pick up before oil prices and as a result provide a synthetic “long oil” position in my portfolio. Unfortunately, it seems that oil futures have once again run ahead of fundamental demand (at least relative to US demand).

Strategically, I believe Valero is on the right track in this downturn. It has reigned in capex, but continues to look to use its industry leading position to find ways to improve the business’ competitiveness. It’s the largest petroleum refiner in the United States, but it hasn’t been complacent expanding into biofuels and making a move into Europe. As the market for fuel and distillates returns, this will only help to ensure that Valero stays on the cutting edge and continues to provide industry leading refining services.

While all the above are important to unlocking value at Valero, my Valero investment thesis is more an asset value play than simply a bet on improving refining margins and that hasn’t changed. Even if you agree with Jim Cramer and other bears out there that say that Valero management has no idea how to run a refiner, the assets the Company owns are worth something. According to the estimates I did in the post linked above, I believe them to be worth at a minimum $12/share and more reasonably $25/share if liquidated. Long term, as the industry rebounds and demand returns, these assets are probably worth significantly more. For a patient investor, this asset value as well as Valero’s continued support of a relatively generous dividend (>3%) should provide reassurance when the rest of the world seems to disagree.

The key to value investing is to invest with conviction when the rest of the market doesn’t seem to agree. Market oscillations and over reactions are a source of opportunity for continued purchasing and dollar cost averaging. Easier said than done. While I’m not selling my shares into the storm, I still find myself a bit shaken by the recent revelations at Valero. Only time will tell if Valero is truly a value or value trap. But, I’m willing to wait.

Disclosure: Long shares of VLO at the time of writing.