Hood also raised the possibility of a bankruptcy down the road.
“The next six-months represent a critical time for Kmart and we would not be surprised if the company were to file Chapter 11 bankruptcy if trends do not improve. We don’t believe a Chapter 11 filing is imminent,” Hood wrote in his research report on Kmart issued Wednesday.
Hood recommended that investors sell their Kmart shares because of below-plan sales in December. The previous rating was “hold.”
Hood also cut his estimates on Kmart earnings. For the fourth quarter, he sees earnings per share down, to 20 cents from 43 cents, and for 2001, he forecast a loss of 12 cents, compared with the earlier 15-cent-per-share profit estimate. Hood also reduced his 2002 estimate to 25 cents from 35 cents.
The analyst said that the earnings reductions place additional pressure on cash flow in 2001 and 2002, with the result that “cash flow and earnings shortfalls jeopardize [Kmart’s] ability to fund its supercenter conversions,” possibly compromising Kmart’s ability to compete with Target and Wal-Mart.
Investors responded by selling shares of Kmart, which closed Wednesday at $4.74, down 72 cents, in heavy volume trading of 23.8 million shares on the New York Stock Exchange. The average daily volume of shares traded is 4.5 million. The previous 52-week low was on Dec. 19, at $4.80. The high was $13.55 on Aug. 8.
Speculation about Kmart and its difficulties surfaced late last summer when vendors started complaining about problems with the discounter’s conversion to its new computer system. More recently, there’s been speculation about payment practices that benefited some larger vendors over smaller ones, leading to rumors about a potential bankruptcy filing sometime around midyear.
In response to the speculation, a spokesman for Kmart said Wednesday: “Kmart has sufficient funds and available lines of credit to continue to carry out its strategies.”
He added that the company is in the process of continuing its implementation of major corporate revitalization strategies that include cultural and operational changes, and that the company has seen some positive evidence of those changes.
The spokesman said that the company has improved its in-stock position, cleared unproductive inventory and moved more merchandise into the stores instead of keeping high inventory levels in the distribution centers. In addition, the company pulled back on the number of planned reductions in circulars during December.
A creditor of Kmart told WWD that while the discounter has some operating issues that will require time to work out, those issues haven’t stopped him from buying shares of Kmart.
“I’m not concerned about cash flow problems,” the creditor said. “I think the whole thing is blown out of proportion. This time last year, you had Bradlees and Montgomery Ward throwing in the towel and now people are making noise that Kmart may be next in this down environment. I don’t see it.”
A credit analyst said, “The company has been very public about saying it doesn’t expect improvement in the first half in terms of profitability, and that efforts in supply-chain management won’t work into the system until the second half. The company expects to have a new bank line in place in May. My concern is whether they’ll be able to get a big enough bank line so that factors will be comfortable about getting paid.”
On Nov. 27, Standard & Poor’s credit analyst Mary Lou Burde downgraded Kmart’s debt, lowering her rating to “BB” with a negative outlook. On Wednesday, Burde described market speculation of a Chapter 11 filing as “premature.” But she added: “Longer term, we’re going to have to see a turn in the business to feel more sure about Kmart’s credit.”
Moody’s Investors Service on Dec. 14 reduced its rating on Kmart’s senior unsecured debt to “Ba2,” a drop of two notches and a move into subprime territory. At the time, Moody’s analyst Philip Emma said the downgrade was predicated on “the continuing challenge that the company faces in obtaining benefits from its turnaround initiatives and converting these benefits into substantial improvements in sales, profitability and cash flow.”