CAN KMART SURMOUNT FORMIDABLE CHALLENGES?

Elliot Zwiebach

TROY, Mich. -- Kmart's merchandising challenges in food and general merchandise may be too steep for the retailer to overcome, observers said.

This comes despite the fact that Julian Day, the former Safeway chief financial officer who was promoted to Kmart chief executive officer, scores good grades from analysts for his financial acumen.

Day was unavailable for comment.

"Kmart's challenge is a merchandising challenge, and Julian Day is not a merchant," Howard Davidowitz, chairman of Howard Davidowitz & Associates, New York-based retail investment banking firm, told SN.

"Kmart needs to develop a compelling offering for consumers that features the right products at the right price, the right value and the right quality, and the notion that a financial executive can formulate and execute that is almost preposterous."

Day was CFO at Safeway, Pleasanton, Calif., from 1993 through 1998, when he left to preside over Sears. He joined Kmart last March as president and chief operating officer and added the title of CEO last month when James Adamson, Kmart's non-executive chairman, gave up the title.

Kmart said two weeks ago it expects to emerge from Chapter 11 bankruptcy protection at the end of April.

According to Davidowitz, "Kmart needs a merchandising leader to come in and build a team, define a strategy and execute that strategy, but the company has spent a year in Chapter 11 and still has not done anything about that.

"Even if there's some kind of divine intervention and Kmart hires the greatest merchandising person possible, it will take at least six months before we will see a new strategy. But how much time does Kmart have?"

Typical of Kmart's merchandising challenges is its inability to maintain gross margins in line with supermarkets, Davidowitz pointed out. "While Kroger, Safeway and Albertsons are running 18% to 19% margins with no problems, Kmart, with its extensive general merchandise mix, can't even maintain 17%, and that's clearly a merchandising problem," he said.

Gary Giblen, senior vice president and director of research for C L King Associates, New York, called Day "one of the most brilliant people in retailing. He's analytical and terrific with numbers, and his forte is gimlet-eyed analysis and strategic decision-making.

"But he's not a merchant or the kind of person who builds an organization, and it remains for Kmart to figure out how to maximize the value of its operations, whether by selling the stores, breaking them up or liquidating."

Another industry executive, who asked not to be quoted by name, had a more upbeat opinion. "Day deserved the promotion -- in fact, it should have happened a lot sooner. He's thoughtful and methodical, and he's made some decisions that were the right ones, and now that he's CEO, I think he'll do a good job."

If Kmart follows through on plans to upgrade its stores, clean them up and make them more customer-friendly, "then maybe it has a chance," the executive said.

"The first step is to eliminate some of the inventory on hand and cut back on buying to make it viable as a smaller company. Then, if Julian Day gets a good merchandiser in there, it may survive, though it will take a couple of years to be successful."

Kmart may not have a couple of years, observers said.

Robert Goch, an analyst with Miller Tabak & Roberts, New York, said he believes the company's emergence from Chapter 11 will improve the balance sheet in terms of debt, "but from an operational perspective, Kmart has done very little in the last year to develop a strategy that defines itself within the discount sector.

"It has said it will open stores with wider aisles, better lighting and stores-within-a-store for exclusive brands, but it has not articulated what will bring customers back to Kmart, so it's not clear if its strategy going forward is all that different from what it's been doing the last several years."

Goch said the announced closings of 50 of Kmart's 117 supercenters seem to indicate the company will eventually exit that format completely. "There may have been circumstances with specific properties or leases at some of the stores Kmart is closing, but if you look at those store closings as a failure of food, then it doesn't bode well for the remaining supercenter locations," he said.

Davidowitz said he believes the supercenter operation will eventually be eliminated totally, "and without the critical mass of food at the supercenters, Kmart's buying power will drop, so the Pantry sections at the Big K stores will also be in jeopardy," he added.

He said he expects Kmart to try to sell the shuttered supercenter locations to raise cash, "but it's waiting till after it emerges from Chapter 11 so it doesn't have to share the money with creditors," Davidowitz noted.

Giblen said the shutdown of more than half the supercenters will eliminate a lot of the economies of scale Kmart has achieved in buying consumables, "and it will be difficult to run half a chain, particularly when it's closing [Super Kmart] stores across a wide geographic area instead of keeping a base in a smaller area.

"And once you make such massive cuts in store numbers, it often signals the beginning of a death spiral.

"It's been part of the history of mass retailing that you never recover from these kinds of cuts. You can leverage market areas on a strategic basis and recover, but when you wipe out stores across a broad geography, it only weakens the remaining stores."

The unnamed industry executive also said he believes the supercenter format at Kmart is dead. "Although Day championed the supercenters early on, the decision to close more than half of them means the format has little future at Kmart," he said. "It's too late for supercenters, and it would be hard to revive the format now."