KMART, FLEMING STOCKS DECLINE ON DIRE REPORT

DAVID GHITELMAN

NEW YORK -- Kmart's equity value fell precipitously last week when a major research firm issued a rare "sell" rating and predicted the discounter faces tough economic times ahead, which could jeopardize its supercenter rollout plans and even push it into bankruptcy.

However, equity analysts told SN that the report, issued by Prudential Securities here, overstated the severity of the challenges faced by Kmart Corp., Troy, Mich.

On the day the report was released, Kmart stock fell 13% to a new 52-week low. Also affected by the news was the stock of Fleming, Dallas, Kmart's exclusive provider of most consumables, which fell 9.2% on the same day.

Prepared by Wayne Hood, an Atlanta-based Prudential analyst, the report said Prudential was cutting its earnings per share estimate for Kmart's fourth quarter from 43 cents to 20 cents, and was projecting a 12-cent loss for 2001 instead of a 15 cent per share profit, based largely on what Hood called Kmart's "weak holiday sales."

The report went on to note that these earnings per share reductions would place additional pressure on Kmart's cash flow in 2001 and 2002, and "would jeopardize Kmart's ability to fund its supercenter conversions."

Kmart has announced a $1.2 billion capital expenditures budget for 2002, according to the report, but this amount "could be cut in half to $600 million." The report also said Kmart's 2003 capital budget might have to be cut by $500 million, leaving the company with $1 billion less to spend on supercenter conversions.

A slowdown in the pace of supercenter conversions by Kmart, the report warned, "could potentially compromise its ability to compete with Target and Wal-Mart."

The report also speculated about the possibility of the company filing for bankruptcy protection. "In our opinion, the next six months represent a critical time for Kmart, and we would not be surprised if the company were to file Chapter 11 bankruptcy if trends do not improve."

A Kmart spokesman told SN, "Kmart has sufficient funds and available lines of credit to continue to carry out its strategies."

Analysts told SN they believe that the retailer does have enough money to carry out its capital expenditure plans and that bankruptcy is not imminent. They also said that Fleming should not be hurt by the speculation surrounding its largest customer.

Mark Husson, an analyst with Merrill Lynch here, said, "We don't think Kmart is going to go bankrupt in six months."

He also said Kmart should be able to fulfill its commitment to buy $4.5 billion worth of consumables from Fleming in the year ending in June.

Kmart's financial challenges would pose a problem for Fleming, Husson said, "only if Kmart closed huge numbers of stores.

"We don't think it's going to close thousands of stores. It still sells loads and loads of food, and Fleming can still do loads and loads of business with it."

Neil Currie, an analyst with UBS Warburg here, also said Fleming is protected from any likely shortfall in Kmart's earnings. "Food is an integral part of what Kmart does. It's a growth part of their business," he said.

Currie also noted that Fleming's forecasts of its own growth are not based on Kmart's expanding the number of its supercenters.

Fleming could not be reached for comment last week.

However, during a conference call late last month, Fleming management gave Kmart's leadership a strong vote of confidence.

Mark Hansen, Fleming's chairman and chief executive officer, said Kmart management "continues to be very focused on how their business is underperforming. We are satisfied with their liquidity, and no doubt they recognize the work in front of them."

Also during the call, Neil Currie, Fleming's chief financial officer, said Fleming's earnings guidance "assumes absolutely no Kmart growth. There is no Kmart growth built into our plans. We had growth of 10.5% outside Kmart, with our price-impact supermarket business growing by 20% during the last quarter."

Kmart is Fleming's largest customer, accounting for approximately 19.9% of total revenues and 23.3% of distribution revenues, Deborah Weinswig, a Bear Stearns equity analyst, indicated.