The stunning announcement of a merger between Kmart (KMRT) and Sears (S) - Get Report mesmerized the financial world last week. Skeptical retail analysts complained that the combination of two terrible chains would not make one great chain, while momentum investors piled into both stocks -- drawn to the action like gamblers at a hot craps table.
From a value perspective, the story reminded me of an old Doris Day song, with an anagramic twist: "When I was young, I fell in love / I asked my sweetheart what lies ahead / Will we have rainbows, day after day / Here's what my sweetheart said / K-Sera Sera / Whatever will be will be. / The future's not ours to see."
While the future is not ours to see, the past is laid out in vivid color, and the history of combinations like this one is ugly. Stakeholders in the new entity are more likely to endure acid fog than rainbows in their new dawn.
If anyone can pull the merger off it will be Kmart skipper Ed Lampert, but it will take much more than financial engineering, real estate sales and a new polish on the blue light. It will take the sort of gritty operational hard work and marketing savvy that has eluded 97% of the retail geniuses in America that aren't based in Bentonville, Ark.
But in case it does work, I would propose a side bet. Value investors likely can't stomach the idea of paying up for two companies that have traditionally led the league in disappointment per share, so I'd consider companies that sell merchandise to either Kmart or Sears now, because these companies could increase their sales opportunity substantially.
Two such companies are apparel makers
Jones New York
. Mind you, neither of these two companies is currently in any shape to win a beauty contest. Sales and earnings trends at both are mediocre at best, margins are weakening and they are beset with management missteps. But both stock prices appear to discount a lot of the bad news, as they are both pretty close to one-year lows.
Kellwood is famous in mainstream department-store circles for its moderately priced lines like Sag Harbor, Koret and Briggs, as well as for its execution of clothes under license from Calvin Klein (women's sportswear), Oscar de a Renta (women's sportswear), Nautica (men's dress shirts) and Levi Strauss (Slates men's tops). It is also one of the top makers of Sears' Canyon River Blues jeans and
Kellwood has suffered because its moderate brands have not performed up to expectations, with product delays and missed fashions. A foray into urban wear via the January acquisition of Phat Farm has proven tough also. J.C. Penney is its biggest customer, at 10% of sales, followed by Sears (9%) and
The company could certainly get a boost if Sears starts selling Kellwood-produced lines like Canyon River Blues into Kmart channels. But it might also find a path to success on its own as its managers find ways to solve their production and acquisition difficulties. Sidoti & Co. analyst Susan Ng said she thinks the worst is probably behind Kellwood, and estimates the company will earn $3.30 per share in fiscal 2005, which at a reasonable 13x multiple would put the stock at around $43, or 25% above the current quote in 12 months.
David Griffith, an analyst at Tradition Asiel Group who worked at Kellwood in the past, said he has been impressed with the company's attempt to move upscale but is less sanguine on the stock, expecting shares to reach just $36 in the next 12 months as two successive blown quarters have left investors feeling that earnings visibility is too cloudy to merit a big commitment.
He prefers Jones, which has been a better-performing stock historically and has mostly tripped recently due to investors' skepticism over its $300-million bid to buy the troubled upscale department-store chain Barneys New York. Jones also may take the opportunity to create branded boutiques within rejuvenated Sears and Kmart stores.
Jones' brands are more upscale than Kellwood's, and include Anne Klein, Nine West, Evan-Picone, Gloria Vanderbilt and licensed items from Tommy Hilfiger, Polo Ralph Lauren, Givenchy and Esprit.
With both near-historic troughs of valuation, and improving sentiment for mid-priced retailers over the Sears-inspired revaluation of department stores, both Kellwood and Jones could find favor over the next year. But, you know, whatever will be will be.
P.S. Don't forget -- now is a great time to get in on bargain stocks before the prices go up. Get my picks with a
TheStreet.com Value Investor
At the time of publication, Markman and his firm was long Kmart, although positions may change at any time.
Jon D. Markman is publisher of
StockTactics Advisor, an independent weekly investment research service, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. He also writes a weekly column for
CNBC on MSN Money. While Markman cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at
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