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Kmart: Who's In Charge Here?


The Corporation: STRATEGIES

KMART: WHO'S IN CHARGE HERE?

October was a pretty lousy month for beleaguered Kmart Corp. Forced to discount heavily to move unwanted inventory, dragged down by turmoil in its executive suite, and faced with rumors of bankruptcy, the Troy (Mich.)-based retailer limped toward a surprisingly big third-quarter loss. So where was Chief Executive Officer Floyd Hall, brought in by the board in June to breathe new life into Kmart? In Cuba and Russia.

Cuba? Russia? Unfortunately for Kmart shareholders, Hall's trip wasn't part of a plan to extend American-style discounting abroad. Despite the growing fires on the home front, Hall left his company behind for a nine-day jaunt with fellow American execs and academics on a tour of Cuba, Russia, India, Vietnam, and Hong Kong that was sponsored by Time magazine. But a picture of Hall in front of the royal palace in Bangalore, India, in Time's Oct. 23 issue--the week Wall Street was ablaze with Chapter 11 speculation--added one more troubling question to Kmart's long list. "People are wondering if [Hall] is serious," grouses one analyst.

BIG CHILL. A lot of questions have been raised about Hall since he took the helm. And as Kmart enters the critical holiday season, investors are demanding answers. In his first interview since taking over, Hall defends his record. There are "no silver bullets" to turning around the $30 billion retailer, he says. "It's a tall order, but we can do this methodically." Billed as the antidote to Kmart's downward spiral under former CEO Joseph E. Antonini, the 57-year-old former head of discount rival Target Stores and Grand Union supermarkets stirred big hopes when he arrived in June. In just 10 weeks, Kmart's shares spurted 25%, to hit 16--a 52-week high.

But unhappy investors have heard little but bad news since. On Nov. 9, they got the latest: On sales of $7.98 billion, Kmart reported third-quarter losses from continuing operations of $118 million. For the full year, analysts polled by investment research service First Call Corp. estimate Kmart will earn only $55 million, from $296 million in fiscal 1995.

With its decline unabated, Hall hasn't convinced many investors that he's got a plan to fix the discounter. While Hall admits he's on the hot seat, he believes Kmart must be fixed "department by department." Despite calls from Wall Street to immediately close 500 stores, Hall plans to shut just 200 over three years. "We can't put a Band-Aid on our problems," he says. "This requires surgery." Yet Hall's lack of urgency may be squandering his grace period. "Hall has managed to fritter away all the goodwill he had," says Kurt Barnard, publisher of the Barnard Retail Marketing Report.

That may be putting it mildly. After Kmart's stock began to slide in late September in the wake of company warnings about the third-quarter loss, Hall met with Wall Street investors and analysts on Oct. 31. But Hall's lack of a strong turnaround strategy--or any hint of what to expect for 1996 earnings--sent a chill through the room. The next day, Kmart's shares plummeted, and they haven't stopped: Since late September, the stock has plunged 43%, to around 8. "We weren't convinced a turnaround was imminent, and we didn't want to spend 90% of our day worrying about it," says James R. McGlynn, portfolio manager of Tom Johnson Investment Management Inc., which just dumped 2.3 million Kmart shares at a loss.

The biggest immediate worry? As the critical Christmas season gets under way, Hall appears to have made little progress resolving Kmart's core merchandising problems. Before Antonini quit under pressure last March, he brought in four key outsiders to rev up Kmart's executive suite. The team included Charles Chinni, a former top executive of R.H. Macy & Co. charged with improving Kmart's merchandising.

But Hall says Chinni's poor picks led to his abrupt resignation last month, after he stockpiled goods better suited for a department store than a discounter. The result: Kmart was stuck with huge inventories it could only sell at cut-rate prices. The blunder angered Hall and led to Chinni's ouster. "There are literally hundreds and hundreds of items that don't fit" Kmart, says Hall. Chinni could not be reached for comment.

Still, critics wonder why Hall didn't take a more hands-on role overseeing the merchandising changes. "This stuff was going on for a while. Why is Hall only finding out in October?" asks one source close to the company. Hall defends his record, saying that he gave Chinni a chance to prove himself. Yet others say that Hall has done little to boost flagging employee morale; some insiders complain that Hall--who still lives in New Jersey and commutes weekly to Kmart's offices in suburban Detroit--isn't known for mixing with the troops. "Floyd Hall? I think I've seen him once in the auditorium," says one manager. Hall argues he is able to work harder without the distractions of family life.

With merchandise orders for Christmas made by Chinni months ago, investors also fear that the die may be cast for another weak quarter. Already, a $140 diamond tennis bracelet that is the centerpiece of Kmart Christmas promotions has come in for heavy criticism as far too upscale.

If the Christmas season does go poorly, Kmart's weak financial position could deteriorate rapidly. In fact, fears that Kmart could end up in bankruptcy proceedings have grown in recent weeks, partly based on a report by analyst Richard L. Church of Smith Barney Inc. arguing that Kmart might benefit by filing for Chapter 11. Then came news that Standard & Poor's Corp. and Moody's Investors Service Inc. may downgrade Kmart's debt ratings. A downgrade to junk-bond status could force the retailer to pay off $681 million in so-called put bonds immediately. Yet Kmart has little financial margin: It plans to use $2.1 billion of its $2.9 billion line of credit to fund Christmas inventories. If the bonds are called, Kmart would need a waiver from its bank to use the remaining credit to pay off the bonds. "If that option is exercised at this point, it could well push them into default," says Gerald Hirschberg, S&P's director of corporate ratings.

LIGHT-YEARS BEHIND. Hall and other Kmart officials are quick to deny they consider bankruptcy an option. "We feel that's totally irresponsible," says F. James McDonald, a director since 1987. "The balance sheet just doesn't warrant it." Indeed, while some Kmart vendors are getting nervous, they have been getting paid. "We still want the business, but we don't want to be left holding the bag if there's a bankruptcy," says one supplier. Kmart now has $470 million in cash, and it is negotiating with bondholders.

Yet even if Kmart gets over its short-term hump, the long term still looks gloomy. Rundown stores, poor merchandise selection, and an ill-functioning inventory system that often means popular goods are out of stock have left Kmart light-years behind rivals Wal-Mart Stores Inc. and Target. Hall's biggest problem may be that people just aren't coming to Kmart enough. According to Kmart's internal studies, Wal-Mart batters Kmart in every head-to-head comparison. Wal-Mart customers average 32 store visits a year, compared with 15 for Kmart. The average Wal-Mart consumer is under 44, has children at home, and has an annual income just under $40,000. Kmart's core customer is over 55, with no kids at home, and earns less than $20,000 annually. "We have lost touch," Hall told analysts.

But rather than moving aggressively to fix those problems, say investors, Hall is tinkering around the edges. Although Kmart has already closed 300 stores since 1993, many on Wall Street argue 500 more stores among Kmart's 2,167 U.S. locations should be shut immediately. But Hall claims that virtually all generate enough cash to cover costs, and he wants to improve their long-dormant productivity. For 1996, Kmart expects to open 50 to 60 new stores, while closing about 70 a year over the next three years. One reason for the go-slow approach: Closing a lot more stores now would likely force Kmart into another huge loss, while quickly renovating the laggards would cost hundreds of millions.

Instead, Hall is testing a "pantry" section--a miniconvenience store selling soft drinks, toiletries, snacks, and other high-volume goods. Hall insists that stocking convenience items could generate five times the traffic in existing stores. But adding low-margin sections is hardly going to be enough. "This potato-chip strategy just ain't going to work," says analyst Barnard. "People aren't going to come to Kmart for potato chips and then decide they need to buy a blouse, a computer, or a television."

CUSTOMER CRISIS. Beyond that, Hall has offered up few specifics other than continued cost-cutting. Over the past two years, Kmart has undergone a massive bloodletting, selling off its specialty stores for $3.5 billion and trimming $500 million in corporate costs. Hall has continued that strategy: Another $300 million in costs will be trimmed in 1996, and he is selling its money-losing automotive service centers for $112 million. Kmart's Canadian operations could be the next to go, bringing in between $200 million and $400 million. Kmart also wants to put its unprofitable Builders Square chain on the block, but buyers aren't clamoring for it.

And divestitures alone won't solve Kmart's core problem: the need to renovate its low-productivity stores and draw a younger, more middle-class customer base. "There's a fuse burning," warns analyst Wayne Hood of Prudential Securities Inc. "The question is, will Floyd Hall have enough time to get the job done?" For now, many of the customers Kmart wants most are busy perusing holiday offerings at competing stores. Rebecca Black recently strolled the men's apparel section of a Target store in Sterling Heights, Mich., with her 2-year-old son, Jake. "I went to Kmart to buy Halloween stuff, but I don't buy any clothes there," Black said. "They just don't last as long." Attention Kmart Chairman: That's a problem that can't be solved in Moscow or Havana.

KMART CEO HALL FACES BIG CHALLENGES

Sales per square foot in 1994 were $185; versus Wal-Mart's $379 and Target's $282.

Kmart's "core customer" is over 55, with an income under $20,000 and no kids at home.

49% of shoppers drive past Kmart to go to Wal-Mart.

Kmart shoppers visit its stores 15 times a year, less than half the visits made by Wal-Mart customers.

Only 19% of Kmart shoppers are loyal to the chain; Wal-Mart wins 46% customer loyalty.

DATA: COMPANY REPORTS

ROB DOYLE/BWBy Bill Vlasic and Keith Naughton in Troy, Mich.


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