Balter Finds More to Love About Sears' Stock

Furthermore, Balter said in his note that Sears' competitive position will probably deteriorate against its best-of-breed competitors like Wal-Mart (WMT Quote - Cramer on WMT - Stock Picks), Target (TGT Quote - Cramer on TGT - Stock Picks), Home Depot (HD Quote - Cramer on HD - Stock Picks), Lowe's (LOW Quote - Cramer on LOW - Stock Picks) and Best Buy (BBY Quote - Cramer on BBY - Stock Picks).

"The square footage growth of Home Depot, Lowe's, Wal-Mart and Target over the next seven to 10 years would equate to sales of roughly [10 times] the current sales of Sears," Balter said. "This type of growth suggests continued market share losses for Sears Holdings, with continuing declining sales a strong possibility."

Despite all that, Balter sees 17% upside in shares of Sears (they were recently trading up $1.29, or 0.8%, to $154.25). He said at current prices, "investors are effectively getting a call option on future changes at Sears Holdings..."

Those future changes might include cost-cuts, margin expansion and purchasing synergies achieved by the merger that have long been Lampert's bread and butter. Balter said he expects Sears to expand its margins by 300 basis points over the next two years, with more opportunities for gains in 2007. In his view, smarter partnering with vendors, direct sourcing and growth in private label products could generate $1 billion for the retailer in the next few years.

Such predictions are notorious for being made in the lead-up to a blockbuster merger, only to be remembered years later by scornful investors when things turn out badly. But in this case, Balter and others point to the track record of Lampert at retailers like AutoZone (AZO Quote - Cramer on AZO - Stock Picks) and Kmart as evidence that Sears will be different.

"At AutoZone, Eddie Lampert has been able to show that he can leverage payables and find margin opportunities well beyond what the street initially anticipated," Balter said. "Also, AutoZone was able to achieve margin expansion even as it continues to comp negatively."

Since Lampert began to exert control at AutoZone in 2002, the auto-parts retailer's margins have expanded 11.2% to an estimated 18.2% in 2005, about 700 basis points. Meanwhile, he achieved similar success with Kmart after engineering the company's bankruptcy reorganization. Before using it to acquire Sears for about $11.5 billion in November, Lampert restored the retailer to consistent profitability, even with declining comps, through dramatic cost-cutting measures.

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