Blue Light Sometimes: Kmart Price War Fails to Materialize

Call it the price war that wasn't.

Worries that Kmart (KM Quote) would trigger a price war throughout the discount industry -- which has caused considerable anxiety among analysts and investors in recent weeks -- appear to have been overblown, according to several recent surveys.

Kmart's decision in May to slash prices on a variety of goods, a campaign dubbed Blue Light Always, sparked jitters that other retailers within the sector, mainly competitors Wal-Mart (WMT Quote) and Target (TGT Quote), would be forced to follow suit. This would provoke a price war in which everyone, including investors, would come out losers. (Consumers would come out winners, but that's not important.)

But according to recent data compiled by several brokerages -- using pricing surveys from various regions of the country -- this has not happened. In some cases the data contradict Kmart's assertion that it is closing the price gap with Wal-Mart, which typically offers lower prices.

Trench Mouth

"Concerns about pricing in the discount industry always seem to arise when sales become difficult and competitors retrench," wrote Jeff Stinson, an analyst at Midwest Research, an independent firm with no investment banking business. "This time around, Kmart's implementation of the Blue Light Always program has sparked concerns by both media and investors. Our research suggests that this move is not likely to trigger a losing price war across the industry." (Stinson has a neutral rating on Kmart.)

Three recently released pricing surveys -- conducted in Atlanta, St. Louis and the Cleveland area -- provide little evidence that such a price war has begun. In the St. Louis survey, for example, A.G. Edwards analyst Robert Buchanan found that the differential in price between Kmart and Wal-Mart was actually widening; he found Kmart's prices, on average, about 13% above Wal-Mart's, higher than a similar survey in March, which found an 8% differential. (Buchanan has a reduce rating on Kmart, and his firm does not have a banking relationship with the company.)

"Granted, our findings apply to just three stores in one market," wrote Buchanan in the report. "But they do not support recent indications by Kmart management that it has begun to close the pricing differential with key rivals with respect to high-frequency items."

Buchanan notes that in a May 17 conference call to discuss quarterly earnings, Kmart management said that on some items recent price reductions narrowed the gap from 8%-9% down to 1%.

A Kmart representative didn't immediately return a telephone call seeking comment. Kmart shares recently traded at $11.69, up 32 cents, or 2.8%. Wal-Mart shares traded at $50.39, up 59 cents.

The Same All Over

Another study, conducted in the Atlanta market by Prudential Securities, found similar results. Prudential analyst Wayne Hood surveyed 170 items at Kmart and compared them with prices at Wal-Mart, Target, CVS (CVS Quote), Walgreen (WAG Quote) and J.C. Penney's (JCP Quote) drugstore chain, Eckerd. "Based on the findings in our pricing survey, we don't believe Kmart has started a price war with its Blue Light Always program," he says. (Hood has a buy rating on Kmart, and his firm does not do underwriting.)

This may be good news for Kmart investors, as few retailers can go head-to-head with Bentonville, Ark.-based Wal-Mart on price and win. Wal-Mart, which is the world's largest retailer and notorious for forcing vendors to do business on its terms, has a lower expense-to-sales ratio than Kmart, based in Troy, Mich., notes Buchanan. The upshot: Kmart can't close that price gap and still expect to make money. "We continue to believe Kmart has limited room to drop prices and still earn a return on sales and invested capital," he says.

Rather, Kmart is better off differentiating itself with unique product lines, such as its Martha Stewart Everyday brand of housewares, say some analysts. Thursday the company said it reached a new exclusive deal with Martha Steward Living Omnimedia (MSO Quote) to continue selling the product line through 2008.

And that seems a better strategy than fighting it out with Wal-Mart on price.