Kmart: The Flood Waters Are Rising

Conaway's rescue plan looks shaky amid bankruptcy talk

Can Kmart Corp. (KM ) avoid bankruptcy? The country's second-largest retailing chain has been scrambling to extend financing that will enable it to survive after a disastrous year culminating in an abysmal holiday season. Viewing Kmart's estimated $400 million in cash and $3.8 billion in total debt, many investors now wonder whether the Troy (Mich.) company's cash flow is strong enough to allow it to stay afloat, let alone implement an ambitious restructuring plan under CEO Charles C. Conaway.

The latest wave of dread began on Jan. 10, when Kmart issued a profit warning and said it was reviewing its business plan and liquidity issues. Major credit agencies slashed Kmart's already low credit rating further, sending it deeper into junk territory. Some worried vendors also began withholding merchandise shipments or demanding immediate payment. Investors, meanwhile, are stampeding toward the exits. Since Jan. 1, Kmart's battered shares have fallen 71%, to just $1.60.

Conaway is now racing the clock, trying to renew and expand $1.5 billion in bank credit by putting up billions of dollars in inventory as collateral. Yet amid swirling rumors that Kmart is on the brink of bankruptcy, company management has remained virtually silent about the extent of its financial problems and its strategy for getting out of the mess. "Things have gone into free fall faster than we thought," is all one high-ranking official will say. But that silence has sapped confidence even further.

Industry insiders agree that if the company is going to save itself, it must radically alter its turnaround strategy. Instead of attacking main competitor Wal-Mart Stores Inc. (WMT ) head-on, Kmart must carve out a less competitive niche for itself. And, they say, the retailer must quickly shutter underperforming stores. "It's a nail biter," says Sanford Bernstein analyst Emme Kozloff.

Although he put in a successful stint as a president of CVS Corp. (CVS ) before joining Kmart in June, 2000, Conaway has had trouble making headway at the retailer. Early moves to improve inventory control and customer service proved smart, but Conaway also has made costly mistakes. His initial strategy was to get more shoppers into stores by lowering prices to match Wal-Mart on more than 30,000 basic items such as toothpaste and diapers. The move backfired when Wal-Mart responded by dropping its own prices even further. Meanwhile, Conaway cut the size of Kmart's advertising inserts in Sunday newspapers: He viewed them as costly and inefficient. But with advertising down, Kmart attracted even fewer shoppers as the economy worsened.

The sorry result: In the quarter ended Oct. 31, Kmart lost $224 million, as sales fell 2.2%. Worse, in the crucial December month, its sales fell 1% as Wal-Mart's surged 8% and Target's rose 0.6%.

How can Conaway reverse Kmart's slide? One no-brainer: He could dump unprofitable stores instead of trying to fix them. Kmart has identified a group of 250 poor-performing outlets. While some estimate closing them would cost about $1 billion, it would let the company direct resources toward more promising urban stores that cater to Latino and African American consumers. That move will take time, but the company also plans to quickly redouble its efforts to promote its private-label brands Martha Stewart Everyday, Sesame Street, and Route 66 clothing. Martha Stewart sales alone grew 25% last year, to $1.5 billion. And with a new seven-year contract that provides increased royalties and minimum sales guarantees, Stewart's company seems solidly behind Conaway's turnaround effort. "You have to credit him with taking on the monster," says Sharon Patrick, president of Martha Stewart Living Omnimedia Inc.

Will Conaway and Kmart have time to implement new plans before the cash runs out? "The silence is working against them," says Robert Goch, a fixed-income analyst at Miller Tabak Roberts Securities LLC in New York. Unless execs start showing publicly that Kmart can surmount its financial hurdles, all the grand ideas in the world aren't likely to be much help.

By Joann Muller in Detroit

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