ANALYSTS: KMART’S OK FOR NOW

Byline: Valerie Seckler — with contributions from Mark Tosh

NEW YORK — Kmart’s got some breathing room.
With an improving balance sheet, cash flow boosted by holiday business and an infusion of key outside executives in the last week, the outlook has brightened.
However, long-term survival remains uncertain, retail analysts said Tuesday, noting that if retailing remains weak in 1996, suppliers and bankers could pull the plug next season if traffic and sales sink. But this season, the support is there.
Kmart named Warren Flick, former Sears de Mexico chief executive, as president of its discount stores last week. On Tuesday, Kmart named Daniel J. Head divisional vice president for sporting goods. Head was a general merchandise manager for Sportmart and also spent 18 years with Target.
“Flick is a great merchant, but the best people in the world can’t solve the problems of a terminally ill company,” noted a retailing analyst who requested anonymity. “It’s the same problem faced at Broadway. I don’t know if there’s a reason for Kmart to exist, with the presence of Wal-Mart, Target and the big-box chains.”
Nonetheless, the near-term outlook is brighter, sources said.
“We have zero Kmart exposure, which may have been a mistake,” said an executive from a factoring firm specializing in the mass market, which recently eliminated its business with the discounter. “If they don’t file [bankruptcy] in January, we would have made more money.”
“Kmart is not filing Chapter 11 in January,” said the retailing analyst. “The earliest they could possibly file is late spring. They’ll have enough cash flow from Christmas until then.
“They won’t be in danger of violating any loan covenants, and I believe they’re pretty close to announcing a deal with the real estate bondholders,” he continued.
As reported, if Standard & Poor’s or Moody’s Investors Service downgrades Kmart’s debt below investment grade, it would trigger a “put” option on $680 million in real estate debt, enabling bondholders to demand immediate payment. It also would trigger defaults on other Kmart debts, according to S&P director Gerald Hirscherg, possibly forcing a bankruptcy filing.
The retailing analyst said the hirings of Flick, who also becomes chief merchant, and Martin Welch 3d, as senior vice president and chief financial officer, suggest that an agreement to solve the “put” issue is about to be struck.
Kmart has consistently denied any plans to file Chapter 11.
“Clearly, the flurry of executive hirings is encouraging,” said Linda Kristiansen, retailing analyst at Schroder Wertheim & Co. “It seems like they’re adding quality people, but the fourth quarter’s a big one, and none of the hires will change things in the short run.”
Something that will help Kmart near term is a balance sheet that has strengthened in the last year, noted Janet Mangano, analyst at Midlantic Bank.
“As long as they can maintain their balance-sheet integrity and their relations with their vendors and bankers, they can survive early 1996,” she said.
Among the improvements the analyst cited in the third-quarter balance sheet of the 2,172-unit chain were a 45 percent reduction in debt interest to $40 million from $73 million; a 42 percent decrease in notes payable to $1.9 billion from $3.3 billion, and a 26 percent decline in current liabilities to $6.5 billion from $8.8 billion.
“I don’t see a Chapter 11 filing in the first calendar quarter of the year,” Mangano added. “The fourth quarter will be very important in determining where they stand and what they can project.”
Isaac Lagnado, publisher of Tactical Retail Monitor, said he believes Kmart is not a candidate for Chapter 11, even though many of its stores are older and smaller than Wal-Mart’s and Target’s.
“The top line is ultimately what you have to start with [in a turnaround],” Lagnado said, noting that same-store sales at U.S. Kmart stores were up 5.4 through November. “Their comp-sales for the last couple of months have certainly been respectable.”
Lagnado said he believes Kmart’s apparel business has been “pretty good,” due in part to the success of private label lines such as Jaclyn Smith and Kathy Ireland.
“Their product development arm has really been a long-term investment and probably is second only to Target’s in terms of intrinsic value and fashion rightness,” he said.
Another positive development for Kmart is the apparent initial success of a new store format, known as the pantry, that doubles the space for consumables to about 8,000 square feet. The concept was tested this year in Fort Wayne, Ind., where sales per square foot rose 24 percent, and has since been tried in other markets.
“So far it seems to be generating incremental volume and cross-over selling, which is generating higher profits per store,” said Jeffrey Edelman, an analyst at CJ Lawrence Deutsche Bank. He said the format could be rolled out “in varying degrees” to many more stores next year.
“The success of these new programs next year will determine whether or not they have the wherewithal to survive,” he said, noting that Kmart’s primary problems involve merchandise assortment and in-stock position, not store size or location. Analysts have also cited Kmart’s higher operating costs, at 23 percent of sales versus Wal-Mart’s 15 percent, and antiquated information systems.
“I don’t think closing down a large group of stores is the answer for their survival,” he said. “Their sales per square foot, while low, have been stable, and that tells me they do have a customer out there.”
Despite its sales gains, which have outpaced Wal-Mart’s for much of the year, Kmart reported an operating loss of $118 million in the third quarter. The discounter said heavy markdowns on discontinued merchandise eroded profit margins, which fell 370 basis points at general merchandise stores.
Robert Burton, director of investor relations, said on Monday the discounter has slowed efforts to clear discontinued merchandise this month.
“We have our seasonal goods in the stores, and we’re doing some tactical marketing things behind specific items, particularly the media campaign focusing on tennis bracelets, toy departments and electronics,” he said.
Kmart last month launched its new television ad campaign, which features Rosie O’Donnell and Penney Marshall. One of the spots highlights diamond tennis bracelets, priced from $59.99 to $139.99 on sale, which have been “doing well,” Burton said. Some retail observers have criticized the bracelets, regularly priced at up to $299, as too upscale for Kmart. However, Burton said it “represents a good bargain for our shopper,” adding: “Given the response that we’ve seen, it is obviously a price point that’s attractive.”
Wall Street’s average estimate is that Kmart will earn 36 cents a share in the fourth quarter, up from 11 cents a year ago. The projection was revised down from 43 cents a share six weeks ago but up from 33 cents two weeks ago.
Mangano forecast Kmart will earn 25 to 35 cents a share in the fourth quarter, saying that if the discounter tops those numbers it will be due to expense controls and lower financing costs. Less bullish was Kristiansen, who expects Kmart to net 19 cents a share in the fourth quarter and lose 25 cents a share for the year.
Despite the positives, industry observers still speculate that Kmart could get into deeper trouble later next year, under the following conditions:
* Sluggish sales, forcing heavy promotions.
* Problems competing with Wal-Mart, Target and big-box chains on merchandise, price, service and housekeeping.
* Lack of funds to remodel or close more stores.
“Kmart, of course, has a need for many new people and new leaders,” said Walter Loeb, president of Loeb & Associates. “But it’s going to take a long time for this new image to be understood by customers. I think the more important thing is that Kmart has to convince the vendor community and factoring community that it’s viable.”
Loeb said it will take nine to 12 months for Kmart’s new image to be visible “because it takes that long for new merchandise to filter through the system onto the sales floor.” He said, “It’s only then that we can tell whether the customers will like the new Kmart merchandise.”

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