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What's up at Kmart (KM
) these days? Plenty. The troubled discount retailer is resurrecting its campy Blue Light Specials, hawking the Martha Stewart line harder than ever, and tidying up its once disheveled stores. Kmart shoppers can thank management and heavy investment in information technology. But are the changes enough to make the company and its high-flying stock a good investment?
Most analysts remain cautiously optimistic about Kmart's metamorphosis. So far this year, Kmart's share price certainly reflects the optimism. Other retailers have been hurt by poor consumer confidence, layoffs, and skyrocketing energy costs that have held the Dow Jones Broadline Retailers index to a slim 2.6% rise, year-to-date. Have you looked at Kmart lately? Since the start of the company's turnaround efforts late last year, the stock has climbed off its low of $5 per share to a 52-week high of around $9. But the question remains: How much further can Kmart shares rise in a difficult retailing environment and growing fears of recession?
Kmart seems to have hit its stride with CEO Chuck Conaway, who was a key player in turning CVS (CVS
) into one of the nation's largest drugstore chains. The last turnaround effort, under CEO Floyd Hall, managed to add some of the company's key brands -- the Martha Stewart housewares line, Route 66 jeans, and Sesame Street children's clothes. Hall is credited with saving the company from bankruptcy in 1995. He managed to meet short-term sales targets by instituting deep markdowns, but many of the fundamental problems went unfixed, analysts say.
CLEARING DEADWOOD. When Hall retired and Conaway came aboard as CEO in June of last year, inefficiencies in distribution required Kmart to store inventory in 15,000 trailers behind its stores. Hall's superstore format provided an immediate boost to revenues, but couldn't keep up the growth pace over time. Worse, many Kmarts were gloomy-looking and poorly stocked, and shoppers complained of poor customer service.
Conaway has swept out executive deadwood, replacing change-resistant old-timers with younger, tech-savvy executives. He has also started to address systemic problems within the company on several fronts -- marketing, customer service, supply-chain management, and inventory control. He has slashed inventory by $700 million. Analysts figure he can raise the total cut to $1 billion within one year.
Also, a massive cleanup effort in the stock rooms of all the stores to improve efficiency is on track to be finished by yearend. The return of the whimsical Blue Light Special (where flashing blue lights announce temporary bargains to in-store customers) is part of Conaway's effort to pull in more shoppers.
The slowing economy might actually help Kmart. Because the company plans to spend heavily on various revamping projects, analysts by and large have low expectations for 2001. The consensus earnings per share forecast is $0.48 for 2001, barely above fiscal 2000's $0.47. At the moment, the turnaround effort -- not earnings growth -- is the focus of the Street's interest. In the near term, Kmart's shares will likely tread water, but over the next several quarters, they could quietly gain momentum if the makeover starts to show signs of boosting the bottom line.
VOLATILE BASE? But a tough economic environment "makes it more challenging to maintain the pace of business while also trying to implement the changes," says Jeff Stinson, an analyst with Midwest Research, who is neutral on the stock. However, even though most retailers feel the squeeze when Americans tighten their purse strings in a downturn, shopping for bargains becomes a must. That's where discount retailers -- including Kmart, Wal-Mart (WMT
), and Target (TGT
) -- start to shine. Although they're not immune to decreased consumer spending, discounters tend to outperform more focused specialty stores and apparel-centric department stores in a rough economic climate.
Kmart shares could be volatile in coming months. That's because its shareholder base will shift from being a turnaround investment to a growth story, says Eric Beder, an analyst with Ladenburg, Thalmann & Co. and one of the few Kmart bulls. Value investors remain big holders of the stock but will likely start to divest large blocks as Conaway makes progress. "If this thing hits the $12-to-$15 range, a lot of people will lighten up on their holdings," says Beder, who expects Kmart shares to climb to $12 within the next 12 months.
But Conaway needs to show to Wall Street his strategy is on course each quarter. If he does that, "investors will get their confidence back and they'll buy the stock again," says Steve Paspal, senior research analyst with Sovereign Asset Management, a subsidiary of John Hancock Funds.
INHERENT RISKS. The Street has a guarded optimism that a turnaround can be achieved in three to five years. But brushing off last year's lackluster performance will be a monumental task for Kmart. The company recently reported a fiscal year 2000 loss of $244 million, on a paltry sales gain of 3.1%, to $37 billion. In contrast, Wal-Mart, the colossus of discount retail, posted net income of $6.3 billion, on a revenue rise of 16%, to $193.3 billion in fiscal year 2000. Kmart's performance gap is huge if you consider that it has 2,105 U.S. stores, 70% as many as Wal-Mart, which has about 3,000.
Kmart's relatively low price-to-earnings ratio of 18 reflects the inherent risks of the company's turnaround. Wal-Mart and Target trade at p-e ratios of 24 and 35 and prices of around $50 and $35, respectively. Kmart is "still at the beginning," Stinson says. "They've put in a very aggressive timeline to turnaround within two years. But we're talking about fixing a company that has been a consistent underperformer for the last 20 years." Still, if Conaway's efforts pan out, Kmart stock could turn out to be one of its best Blue Light Specials ever.
Tsao covers financial markets for BusinessWeek Online in New York Edited by Thane Peterson
Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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