Dear Mr. Berko:

Can you please tell me how such a huge company like Kmart could get in so much trouble that it had to declare bankruptcy? I just can’t believe that it could happen to such a prominent and well-known company that has been part of this country for 40 years or more.

I want to know if you think the new Kmart, which came out of bankruptcy and is $27.20 a share, would be a reasonable speculation? I would like to buy 300 shares if you think the company has a decent chance to do well and double in price within the next two or three years.

H.S., Joliet, Ill.

Dear H.S.:  

I fondly recall Kmart Corp.’s glory days way back in 1992, when it had revenues of almost $40 billion and earned $4 a share. It was trading at $53 and paid a $1.60 dividend for a yield of 3 percent.

Shortly after its 2-for-1 split in mid-1992, however, Kmart began to traipse downhill. It just couldn’t compete with Wal-Mart, Target, T.J. Maxx and the megamalls. I liked shopping at Kmart. It had excellent prices on film and toiletries and a good selection of top-of-the-line sporting goods. I especially enjoyed the warm buttered popcorn, great sandwiches, hot dogs and tasty pizza slices.

Unfortunately, management didn’t have the skills to compete in the new, fiercely competitive retailing environment. Merchandise displays became helter-skelter. Some customers decided not to return.

In attempts to increase revenues, management crammed more merchandise on the floors and the aisles became crowded. More customers stayed away. The stores began to deteriorate, taking on a gray, unclean ambience, and the exteriors needed, but didn’t get, cosmetic maintenance. Still more shoppers stayed away.

Merchandise quality began to decline, customer service levels slipped and new marketing programs failed to bring back those who had left. The competition was eating Kmart’s lunch, and Kmart’s management was left with the crumbs.

Wal-Mart, whose revenues in 1992 were $58 billion, blasted to $245 billion last year. Target’s revenues in 1992 were $16 billion and grew to $40 billion last year while T.J. Maxx’s revenues zoomed from $2.8 billion to $11 billion.

These retailers and others opened bright, new, attractive units. Their merchandising programs were tailored to the demographics of their selling areas. They had good employee training programs and worked hard to place the best possible people in their stores. They just outsmarted, outmarketed and outmanaged Kmart by a million miles until Kmart, in January 2002, had no choice left but to declare Chapter 11.

Kmart’s ignominious failure was a classic example of inutile management.Kmart (KMRT-$27.20) is out of bankruptcy, and Edward Lampert’s ESL Investments (a hedge fund) owns 50 percent of the new Kmart with the right to appoint four of its nine directors.

The company emerged from bankruptcy with 57,000 fewer employees, 600 fewer stores (it now has 1,500), 80 percent of old debt erased from its balance sheet and a management team that should have the necessary pluck and dash.

Kmart had first-quarter revenues of $4.07 billion, and gross margins were a higher-than-expected 21.4 percent. Cash flow, at $433 million, was also better than expected, and EBITDA (earnings before interest, taxes, depreciation and amortization) was $51 million. Attaining those results required some serious surgery. Kmart is still in intensive care with good hands prescribing the right meds.

Management has prescribed a three-part marketing strategy to be competitive. It will offer low prices for selected items to attract shoppers, concentrate on promoting and building up brands such as Joe Boxer and Disney Kids, and placing merchandise on its shelves that reflects the demographics of each store.

Julian Day, the company’s chief executive, is positioning Kmart as a “high-low” retailer with frequently changing special offers on various store items.

Despite all of these changes, Wal-Mart’s “everyday low pricing” approach is hard to beat.  Day is creating a new “store of the neighborhood” image for Kmart which could bring back core shoppers. If he succeeds, he and his new team, as well as Ed Lampert, will benefit enormously.

Day and his team do have some momentum on their side. Kmart has more recovery potential ahead of it, but in my opinion not enough to buy the stock at $27.20.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.