Attention Kmart Investors
Last December, Kmart (KM) shares were briefly marked down to a 20-year low of $5 — only to roar back 75% on a wave of positive press.
Is the recent Kmania justified? Maybe not. At nearly 18 times 2002 earnings, Kmart shares are suddenly trading at a chunky premium to more financially stable — though still catatonic — competitor Sears (S), a former Dow component whose 2002 price-to-earnings ratio is just 7.5.
More to the point: Because Big K managed to fumble so badly through the 1990s retailing boom, it's not exactly a given that it will manage to thrive now that the climate for retailers has become much less forgiving. Just take a visit to your local store — which should be easy for most of you, since 85% of the U.S. population lives within 15 miles of a Kmart. More likely than not, you'll be confronted with the unsightly reality of unkempt shelves, checkout-line bottlenecks, too much merchandise no one seems to want and too little of the stuff they do — the same problems that have been dogging Kmart for years.
Nevertheless, shareholders have been bidding up Kmart in the hopes that new Chief Executive Charles Conaway can deliver on his promise to turn this industry laggard into a world-class operation. His first move: a $2 billion effort to beef up the substandard technology and distribution systems that caused Kmart's notorious inventory headaches of yore. Recently, he announced the purging of nearly 15,000 tractor-trailers of inventory that had been hogging up space in the backs of Kmart stores, jettisoning the costly dead weight of old stock to clear the way for new goodies. And just Thursday, Kmart announced a $200 million deal with IBM (IBM) for faster checkout-line systems.
In early January, meanwhile, Kmart unveiled plans to open a state-of-the-art $100 million megadistribution center near Albany, N.Y., in 2002. That'll provide a desperately needed supply-chain boost for the retailer, whose distribution centers are consistently the most overworked and least efficient in the discount department-store industry. The company's on-shelf, in-stock positions — a metric that measures the extent to which products are available for immediate sale — currently sits around 86%, while Wal-Mart Stores (WMT) and Target (TGT) enjoy a 95% rate. Realizing now more than ever how customers have the luxury of crossing the street to a rival when Kmart has nothing to proffer but a rain check, Conaway is shooting for 98% by 2002 — an eye-poppingly ambitious goal that the Street will surely hold him to. Moreover, the intrepid CEO ultimately wants to slash excess inventory levels by as much as $2 billion.
Gambit No. 2 of the Chuck Conaway era: a bold push into the supermarket business. A week ago, Kmart announced a 10-year, $4.5 billion deal to lock in food distributor Fleming (FLM) as its sole grocery supplier, instantly turning the discounter into one of the biggest food purchasers in all of retailing.
This sets the stage for an accelerated rollout of its SuperK concept of giant Kmarts, which combine the chain's traditional discount stores with supermarkets and other services. Kmart's 104 SuperKs (out of 2,016 total outlets) are nowhere near Wal-Mart's near 900-store armada of Supercenters, but that's clearly the goal. Meanwhile, the Fleming deal should save Kmart more than $200 million by the third year, thanks to economies of scale in purchasing. In addition, the company says the arrangement allows it to pocket nearly $1.7 billion it would otherwise have spent distributing food itself.
While cost-cutting and improved inventory management are nice, Kmart still struggles with, let us say, something of an image problem. Shopping at Kmart is still perceived by many to be a less-than-desirable experience at a time when svelte rival Target — pronounced "Tar-zhay" by ironic twentysomethings — is hitting the marketing bull's-eye with its cheap-is-chic image. A Wall Street favorite, Target trades at 23 times forward earnings.
And there's no denying that Kmart faces an increasingly difficult environment for all retailers, especially those dogged by a reputation for crumminess. Competitors Wards and Bradlees (BRADQ), for example, are in liquidation. And even Kmart had been a rumored candidate for bankruptcy last fall.
But Kmart has at least one important supporter. Ronald W. Burkle, the supermarket tycoon who now runs Yucaipa, an investment company, has amassed a 6% stake in Kmart since September and has obtained regulatory approval to snatch up a total of 15%. Burkle (who has received a good deal of media coverage lately as a chief lobbyist in the unsuccessful effort to win a presidential pardon for former junk-bond king Michael Milken) is famous in the business world for turning around and then selling West Coast supermarket chains Ralph's and Food4Less. And although the grocery mogul declines to comment on whether he might be interested in trying a similar feat with Kmart — or perhaps launching an outright takeover bid — his company disclosed last week that it's also taking an 8% stake in food distributor Fleming. That move could be a precursor to a merger of the two very distinct retailing entities.
However the Burkle situation plays out, analysts agree that Kmart shareholders have gained a powerful institutional interlocutor whose presence will make it difficult for management to slack off in its turnaround efforts.
Dan Binder of the Buckingham Research Group, who upped his view on the stock from Sell to Neutral before its January run-up, has this to say about the company: "The deterioration has stopped," he says. "Keep in mind that nobody is looking for Kmart to become the next Wal-Mart. But when a bad company becomes a mediocre company, you often get a great stock."
Faint praise, to be sure, but it's the best thing that could be said of Kmart in a long time
