People who can't keep up with a slug slithering across the street might prefer instead to watch Kmart's (NYSE: KM) determined drive toward efficiency. The discount department store, home to Martha Stewart merchandise, reported fourth-quarter earnings per share (EPS) of $0.77, up from $0.65 a year ago, and total EPS for fiscal 1999 of $1.22 (excluding losses from discontinued operations), surpassing last year's $1.01. Analysts were expecting $0.69 for the quarter and $1.18 for the year, according to First Call.

Kmart really worked to squeeze 17% EPS growth out of a 6.6% increase in annual sales and a 4.8% comparable-store sales increase. They did it by cobbling together small decreases in various segments of the income statement: SG&A, as a percentage of sales, was 18.2% in 1999 versus 18.5% in 1998; the company's early retirement plan expired; and interest payments dropped 4.6%. As a result, operating margins increased from 3.2% to 3.6% and net margins grew from 1.5% to 1.8%.

Little improvements are the key to success in the discount-retailing sector. With every baby step, Kmart becomes more profitable. The trouble is that its main competitors, Wal-Mart (NYSE: WMT) and Target (NYSE: TGT), have for some time been taking big-boy steps, continuing to grow significantly faster than Kmart. As a result, Kmart has long looked more unappealing to investors, as this 10-year chart illustrates. See the flat line? That's Kmart's heartbeat on Wall Street.

Last year, Target (just the eponymous store, not the whole company) achieved net margins of 6.4% on increases of 13% in revenue and 6.7% in comparable-store sales. Wal-Mart, on similar revenue and comps increases, had 3.3% margins. Since 1996, Target has seen total sales rise 46%. Wal-Mart's have shot up 77%. Kmart's have grown a scant 14%.

Why do Kmart's sales and margins lag behind its competitors? I'll give you my take, which can be summed up in two words: inventory management. Last year, Kmart improved its inventory cycle from 89.5 days to 88.5 days. That means that Kmart turns its inventory 4.1 times a year. While it's nice to see some improvement on this front, Kmart has a long way to go to reach the level of its competitors. Target and Wal-Mart both turn their inventory over about 7 times a year. Wal-Mart also leaves its accounts payable outstanding longer than Kmart, so that Wal-Mart runs through its cash conversion cycle 16 times a year compared to Kmart's 6.

To give you an idea of how much this slower inventory turnover hurts Kmart, consider this: If Kmart turned its inventory at the rate that Wal-Mart does, it would have had $11 billion -- yes, billion with a "b" -- more cash at its disposal over the course of the year. $11 billion sat tied up in inventory on Kmart's shelves. What else could Kmart have done with that money? It could have advertised more. It could have paid back more of its debt. It could have finally given some of its stores the makeover that they have been begging for since the '70s.

It could have been so much more than it was.

Kmart has to do more than take sluggish steps toward efficiency. Without major changes, don't look for a heartbeat from Kmart anytime soon.

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