Out of Bankruptcy but Not Out of the Woods at Kmart

Kmart emerged from bankruptcy on Tuesday with much the same question it faced going in: Can the troubled retailer compete successfully against the likes of Wal-Mart ( WMT) and Target ( TGT)?

While the emergence signals that Kmart is willing to give it a try, some retail analysts don't give the company much of a chance. Kmart faces long odds and tough challenges as it tries to turn around its operations, they say.

"Going into bankruptcy relieved them of a lot of burdens, but what it hasn't done is relieved them of the ultimate burden: They just don't have a compelling story for consumers," said Russell Jones, president of Decisive Retail Technology.

Struggling with below-plan sales, intense competition and lack of confidence from suppliers, Kmart filed for Chapter 11 bankruptcy last year; at the time, it was the largest such filing by a retailer.

Over the last 15 months, the company has replaced its chief executive officer twice as part of a management reshuffling and gone through two rounds of store closures, shuttering about 600 outlets in the process.

The company is emerging from bankruptcy with about $6.4 billion in current assets, including $1 billion in cash, compared with about $2.4 billion in current liabilities. Kmart also has a $2 billion credit facility that it can draw on for working capital.

Kmart issued new shares of stock to debt-holders, including Edward Lampert's ESL Investments. The company canceled its old stock. The new shares will trade on the over-the-counter market until the company can meet the listing criteria for the Nasdaq or another national securities market, Kmart said.

Lampert, who helped resurrect automobile parts company AutoZone ( AZO), will serve as chairman of Kmart's board.

"This is a momentous day for Kmart," company CEO Julian Day said in a statement. "Kmart emerges from Chapter 11 as a new and vital enterprise focused on delivering value to customers and stakeholders alike."

Much has been made about the speed with which the company emerged from bankruptcy, but Jones noted that retailers don't have a very good track record after emerging from bankruptcy, regardless of how long they spend in it. Indeed, the only notable retailer that has been successful after bankruptcy in recent years is Federated ( FD), he said.

"Retail in general is a model that doesn't seem to be amenable to improvement through bankruptcy," Jones said. "Much of the problem stems from the fact that in order to be in such bad shape to enter bankruptcy, you had to be so far out of touch with consumers that small changes aren't going to bring them back into the store."

If Kmart is to buck those odds, it's going to have to figure out its niche. As of yet, the company hasn't articulated a detailed strategy.

Before entering bankruptcy, Kmart struggled to profitably compete with Wal-Mart on price. And despite offering Martha Stewart-licensed products, the company hasn't been able to match Target's array of low-priced, stylish offerings.

But Kmart faces other competition as well, from drugstores to supermarkets to discount and dollar stores, notes Richard Hastings, a retail analyst with credit agency Bernard Sands.

Most of the competitive problem facing Kmart is primarily time itself," Hastings said. "They don't have lot of time. The competition is strong today, but it's getting stronger faster than Kmart can improve its business."

And Kmart will need to make improvements, retail analysts say. The company will need to renovate its existing stores to make them more appealing for shoppers. For too long, Kmart shoppers faced a disconnect between advertisements that made the company look great and their actual store experience, which was often disappointing, said Kurt Barnard, president and chief economist of Barnard's Retail Consulting Group.

"Kmart has to work very hard to win back those shoppers," Barnard said.

The problem for Kmart is that its bankruptcy filing will likely make lenders reluctant to lend it the type of capital it will need to make improvements, Jones said.

Even if Kmart does get the money it needs, it will likely have to accept poor terms, he said.

"The kind of changes Kmart needs to bring customers back into the store are going to require a lot of investment that no one on Wall Street is going to tolerate," Jones said.

To be sure, Kmart still has a chance. As Hastings notes, the company's same-stores sales haven't been all that much different from its competitors' in recent months. Meanwhile, Kmart generated positive cash flow in December and posted sales of $30.8 billion in its last fiscal year, despite operating in bankruptcy.

"They will in short order have to develop a strong, persuasive, very appealing strategy that differentiates them clearly and very desirably from their principal rivals," Barnard said. "If they can do that, they've won for themselves a real lease on life, maybe a permanent one."

Regardless of how the company fares long term, Kmart's emergence from bankruptcy likely will have little short-term impact on other retailers, analysts agree. Those retailers have already faced off against a company in bankruptcy that had the opportunity to lower costs and cut prices. Kmart's freedom of movement on that front will be much more limited after bankruptcy, they say.

"I don't think this will change the landscape much," Jones said.

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