By Christine Tierney Kmart is gearing up for a comeback after emerging from bankruptcy on May 6 with $2 billion in fresh financing. After closing 600 of its 2,114 stores and tackling logistical problems and questionable accounting practices that contributed to the largest-ever retail bankruptcy, new CEO Julian Day expects to bring Kmart's core earnings into the black in 2003. He's sprucing up stores and devising special offers to lure customers back.
Is it safe for investors to bet on the new Kmart Holding Corp. (KMRT)? Retail experts are wary. Kmart's sales are still falling, even though the Troy (Mich.)-based chain has shuttered its worst-performing stores. Meanwhile, rivals Wal-Mart (WMT) and Target (TGT) are expanding.
Unless Kmart's management can improve sales, it'll have no revenue for expansion and little scope to increase profit margins, says Howard Davidowitz, head of national retail consultancy Davidowitz & Associates in New York. He says Wal-Mart has helped drive dozens of discounters out of business, including Ames Department Stores, which came out of Chapter 11 twice before liquidating. Says Davidowitz: "Kmart wasn't viable when they went into bankruptcy, and they aren't viable now."
HANDS-ON CHAIRMAN. Yet investors have at least one compelling reason to keep an eye on Kmart: the solid track record of its largest shareholder, Edward Lampert. Since last summer, he has poured $387 million into the retailer. His hedge fund, ESL Investments, now owns around 50% of Kmart, as well as stakes in the dealer chain AutoNation (AN), and it recently bought 8.9% of Sears Roebuck. (S). According to Institutional Investor's 2002 ranking of funds, ESL Investments generated a 53% return in 2001, excluding fees -- the best of the 20 largest hedge funds on the list.
Past success is no guarantee, of course, but Lampert has been deeply involved in helping Kmart cut costs and improve its logistics. As the new chairman, he'll remain active. Shareholders -- many of them creditors -- are waiting to see how Lampert and the new management team handle the next key appointments. Kmart has stumbled without a chief merchandising officer for a year, and Day's expertise is mostly financial.
Lampert's history suggests he knows the business. One ESL investment, auto-parts retailer AutoZone (AZO), has thrived since Lampert began appointing executives and pushing for shifts in strategy. "He's very hands-on," says a Kmart executive. "He and his people work 24 hours a day."
MATCHLESS RIVAL. Still, it may take more than hard work to turn this ship around. Certainly, the new management has halted the dubious accounting practices and embarrassing loan deals to executives that led to the ouster of former CEO Charles Conaway, indictments of two lower-level execs, and a restating of filings.
Going forward, Day's "back-to-the-basics" strategy sounds sensible -- but underwhelming, given the strength of Kmart's competitors. "With all of Lampert's past achievements and credibility, Kmart still hasn't defined a compelling, revenue-building strategy," says Arnold Aronson, managing director of retail strategy for Atlanta-based consultants Kurt Salmon Associates. Wal-Mart is matchless when it comes to low pricing, and Target lures buyers with relatively inexpensive but trendy, eye-catching products.
Day is countering by revamping the logistics at Kmart and gradually giving local managers more say in ordering merchandise. He wants to attract customers with promotional sales -- hardly groundbreaking for a discounter -- and exclusive brands, including Joe Boxer, Disney apparel, and the slightly tarnished Martha Stewart label. Still, Day doesn't expect a rebound in same-store sales before 2004.
AHEAD OF SCHEDULE. That's a long time for investors with a short-term horizon. The new shares, which began trading at $15 over-the-counter after Kmart's exit from Chapter 11, had slipped to $14.35 on May 14, as some creditors sold stock to recoup a bit of their money. Ulysses Yannas, a retail analyst at Buckman, Buckman & Reid in New York, is optimistic about Kmart. While Yannas regards Day highly and likes that the new chairman is a majority owner, he isn't a buyer yet. He says the stock would be attractive if it fell below $10. The market's estimated valuation range is $8 to $15.
Investors will be watching the quarterly performance closely. Kmart had forecast that its core earnings, or EBITDA (earnings before interest, taxes, depreciation, and amortization), will reach $75 million this year. But on May 6, Day said Kmart was well ahead of schedule in meeting that goal, and he's offering an extra bonus for executives if this year's core earnings reach $375 million. That kind of talk is bound to pep up the demoralized ranks. And making the numbers would certainly perk up investor interest. Tierney is a correspondent for BusinessWeek in Detroit