Reinventing Kmart

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By Mathew Emmert (TMF Gambit)
June 16, 2003

Kmart (Nasdaq: KMRT) reported a narrower-than-expected loss today, and its freshly minted shares are singing because of it. But will investors who were only once shy be twice bitten?

After all, it's been less than a year since shareholders of Kmart's original equity were wiped out by bankruptcy proceedings, yet apparently there are still plenty of folks who are willing to hitch their success to the back of this shopping cart.

Kmart emerged from bankruptcy protection just last month after stiffing creditors to the tune of about $7 billion. Its new shares, which the company issued to pay down debt, hit the Nasdaq last week. The unfortunate news for investors who are snatching the new stock up like it's a Blue-Light Special is the company is still much the same.

Make no mistake: Despite the green arrow in front of the stock price today, this is a weak business. Kmart reported a $1 billion drop in net sales today, but that number appears worse than it is due to the 316 stores it closed as part of its bankruptcy restructuring. Still, same-store sales dropped 3.2%, and that number is as real as real can get. Couple that with the fact that its distribution infrastructure is inefficient and its gross margins remain weak compared to competitors, and you're left feeling a little blue (without the special).

The company also has a big image problem. That might not be too serious in another industry, but it's life or death for a retail firm. When Tom Cruise's character in Rainman brashly stated, "Kmart sucks," I thought it was a seminal moment for the company -- the beginning of the end. That statement may have been a bit harsh, but investors who lost it all on the company's original equity probably share the sentiment.

Kmart's emergence from bankruptcy in a weak economy and an intensely competitive retail environment is a risky move, especially when you consider that many of the problems that drove the firm into bankruptcy still exist.

The new management team is certainly a strong point, and the company has adequate liquidity (thanks in part to the issuance of the new shares). But as long as the retailer is getting its clock-cleaned by Wal-Mart (NYSE: WMT) and Target (NYSE: TGT), it's going to take some serious magic to turn this frog into a prince.

If you find yourself wanting to take a flier on this turnaround story, just remember that history isn't on the side of those who go digging in the bottom of the retail basket. Often, all they come out with are a melted Icee and a few leftover coupons.

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