Colin Barr

Following the money in banking, economics, and Washington

Dillard's strikes real estate gold

January 20, 2011: 11:00 AM ET

Getting shinier

Are struggling department stores sitting on a real estate gold mine?

Wall Street certainly hopes so, judging by Thursday's furious rally in shares of Dillard's (DDS) and the smaller gains in JCPenney (JCP) and the biggest laggard of them all, Sears Holdings (SHLD).

Dillard's surged 17%, JCPenney 6% and Sears 5% after Arkansas-based Dillard's said it intends to set up a real estate investment trust that will allow it to borrow against the value of the property it owns. The 310-outlet chain owns 87% of its stores, Deutsche Bank estimates.

"This is a very positive development for the shares given DDS's significant -- and under-valued -- real estate ownership," says Deutsche Bank analyst Bill Dreher, who rates Dillard's stock buy.

The news also helped shares of some Dillard's competitors, which are forever under siege from discounters such as Wal-Mart (WMT). Dillard's same-store sales, measuring sales in stores open at least a year, rose just 3% in the 48 weeks ended Jan. 1. Same-store sales at Sears stores tumbled 8% in the third quarter.

So how big is the gold mine, and what might Dillard's do with it?

Dreher estimates the value of Dillard's real estate holdings at around $2.8 billion. He says this collateral could allow the real estate investment trust to borrow, say, $1.7 billion.

Dillard's says in its filing that forming the real estate investment trust, or REIT – a structure that pays out 90% of its profits in dividends to shareholders – may "enhance its ability to access debt or preferred stock and thereby enhance its liquidity."

But Dreher surmises the firm would use funds freed up by the REIT's creation to do things like buy back stock, which would boost per-share earnings and presumably lift the stock price.

Of course, Dillard's stock is already trading at its highest level in years, but hey, executives everywhere have a proud history of buying high and selling low, so why not?

In any case, a new source of cash might naturally be attractive both Penney and Sears, which have reported soft results as strapped consumers pull back on their spending.

"This announcement could force a reappraisal of the negative stance that many of the department stores have been viewed by the investment community over the last 2 months," writes Credit Suisse analyst Michael Exstein. "If the transaction were to be completed, significant attention will be placed on the value of retail real estate going forward."

The rally in Sears is especially ironic in this light, as hedge fund manager Ed Lampert took over the company and rival Kmart during the housing bubble with the intent of cashing in on their undervalued real estate holdings. Those who have ridden the stock down to a recent $76 from its 2007 peak near $200 surely haven't forgotten.

But even if Dillard's does move forward with its real estate move, Credit Suisse's Andrew Rosivach notes that many questions about just what the company is getting into, and why, remain unanswered for now.

The announcement was bare. All the release said was that a private REIT was being formed. No language was given as a spinoff or separate listing. We also found it odd that the premise was based on debt/preferred access rather than unlocking shareholder value (ie-sell the real estate and the operator is free).

But if your lunch is getting eaten by Wal-Mart, you'd might as well try something.

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for since November 2007. Previously he was a writer and editor for, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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