Kmart Soars on Upgrade
Updated from March 10
UBS issued a boldly bullish call on retailer
Kmart
(KMRT)
, saying the stock -- which has quintupled since the company emerged from bankruptcy in May 2003 -- has another 40% of upside.
Kmart was up $8.60, or 7.7%, to $120.71 Friday morning. Merger partner
Sears
(S) - Get Report
rose $2.64, or 5%, to $56.
UBS analyst Gary Balter upgraded Kmart to buy from hold and raised its price target to $160 from $100, predicting the company will be able to wring $5 billion additional cash flow out of its merger with Sears. Balter cited "asset sales, cross-selling of proprietary brands and cost savings."
Kmart agreed in November to acquire Sears for cash and stock worth more than $11 billion. The stock was trading around $100 at the time the transaction was announced. It has since spent time in the low $90s before rallying in March to a Thursday close of $112.11.
Balter, who conceded the stock has major risks, said the call contemplates a valuation of 3.1 times estimated 2007 earnings before interest, taxes, depreciation and amortization. It also depends on the ability of controlling shareholder Ed Lampert to create cost savings at the post-merger retail chain.
Lampert, who orchestrated Kmart's bankruptcy reorganization, originally got Kmart's stock aloft by selling off real estate and creating the perception on Wall Street that he has grander plans for the chain. In his call, Balter noted that the hedge fund manager could have less wiggle room at the combined company.
"This story has more risk than any other we cover," Balter said. "Unlike pre-merger Kmart, the asset support does not offer as much protection, and the commodity nature of Sears key products make one key element of the
Lampert story, price increases, less available. Yet, the potential for cost-cutting and vendor support is compelling."
Despite the risks, Balter pointed to
AutoZone
(AZO) - Get Report
as a guide to Lampert's strategy in fixing companies. Lampert bought a stake in the auto parts retailer at around $30 a share in the late 1990s. The stock closed Thursday above $98.
As an active investor, Lampert turned AutoZone around with a prescription of cost-cutting and a focus on return on investment at the expense of sales growth. AutoZone increased its store count only 10% from fiscal 2000 to 2003 and 6% in 2004, after expanding 18%, on average, from 1993 through 2000.
Half a decade later, it continues to show cost-savings that are a result of Lampert's strategy. Balter said Lampert's fixes usually work best early on.
Meanwhile, Sears suffers from one of the highest costs per square foot in its industry, leaving ample opportunity for the investment guru to go to work. Its assets, which include an extensive real estate portfolio and catalogue unit Land's End, could offer significant upside in valuation.
Balter does not own shares in Kmart or Sears, and his firm has no investment banking relationship with the companies.