As Sears Holding (SHLD), a HypeZero recommendation, spins off Sears Hometown and Outlet Stores, let’s look at the state of the company that it spun off less than a year ago, Orchard Supply Hardware Stores Corporation (OSH).
Orchard owns and operates 88 home improvement stores in California. The company was spun off Sears on December 30, 2011. For every 22.141777 shares of Sears Holdings, investors received one share of the Class A Common Stock and Preferred Stock. The Class A Common Stock trades under the symbol OSH on NASDAQ. The Preferred Stock trades under the symbol OSHSP on OTCQB.
Orchard is a small fish in an ocean full of sharks. Its main competitors are Home Depot, Lowe’s, Ace Hardware and True Value. It also competes with discount retailers such as WalMart, Target and Costco in some of their product lines. To get an idea of its size, Orchard’s fiscal 2011 revenue was $660 million and Home Depot’s fiscal 2012 revenue was over $70 billion. Home Depot’s stores are more than twice the size of Orchard’s stores and produce almost four times the revenue. The larger competitor stores give their consumers more variety and better pricing.
While Home Depot’s revenue, profits and comparable store sales have been increasing since 2009, Orchard’s have been going down year after year. In the first two quarter of this year, all three went down again, and the company is no longer profitable. As a result, there has been liquidity concerns. The company is running low on cash and is struggling to maintain compliance with certain covenants that would allow it to borrow money. Non-compliance could mean that certain debt that is maturing in the future would be due now. And a default in one agreement could mean a default in other agreements.
Because of the deteriorating results, the company would not have been in compliance with the leverage ratio covenant on July 28, 2012 had they not completed a six-store sale and leaseback transaction. The company is pursuing all measures to alleviate the liquidity problems. The next measurement date to see if it meets all its covenants is October 27, 2012. It is a bit of a coincidence that investors have to exercise the subscription rights on Sears Hometown and Outlet Stores offering before October 8, 2012 (right before the measurement date).
It only gets tougher for Orchard from here. The first two quarters are seasonally the best for business.
The biggest holder of Orchard, ESL Investments (Eddie Lampert), has been selling its stake in OSH. ESL Investments decreased their holdings by almost 23% in their latest quarterly filing at the end of June. Fairholme Capital Management has also decreased its stake.
One thing to note is that Lampert has been buying up the Preferred Stock at around $1.60/share. The Preferred Stock has no voting power, no conversion rights, and no dividend. However, it has to be redeemed for $4.16 in case of 3 events: before a dividend on the common shares (not going to happen), before any repurchases of the common shares (not going to happen), or in the event of a company liquidation (maybe this will happen). Nobody is sure of Lampert’s motives because in the event of a liquidation, there might not be anything left for the Preferred Stock holders after the debtors take their cut.
Whatever the reason is, the future does not look bright for Orchard. With their poor performance, liquidation problems and their business in a highly competitive industry, it is hard for us to see Orchard turning itself around.
Disclosure: I am short OSH.