Moody's Investors Service confirmed the ratings of Kmart Corporation following the company's announcement that it will record a $230 million after tax charge to cover the cost of its obligations in connection with guarantees of leases on its former Builders Square stores. Since Builders Square's 1997 combination with Hechinger, the Builders Square stores have been operated by Hechinger Company, which today filed for bankruptcy. The rating confirmation reflects the fact that the existing ratings on the Kmart securities already incorporated the potential that Kmart could be called upon to make payment pursuant to the guarantees of the Builders Square leases. The ratings are based on the company's ongoing progress in improving merchandising, operations, and financial performance. The rating outlook remains positive. Prospectively, the company's ratings could be raised if it continues to improve its financial performance and maintain prudent financial management. Key to that improvement is a successful upgrade of its management information systems and logistics, thereby enabling the firm to make additional meaningful progress in improving merchandising and operations and further enhancing earnings, cash flow and debt protection measures.MOODY'S CONFIRMS RATINGS OF KMART (SR. AT Ba1); MAINTAINS POSITIVE RATING OUTLOOK
Ratings confirmed are:
Kmart Corporation -- $2.5 billion bank revolving credit facility; senior unsecured debt, medium term notes, guaranteed industrial development bonds, and its issuer rating at Ba1; non-guaranteed industrial development bonds, and lease certificates at Ba3; unsecured senior debt shelf registration at (P)Ba1; subordinated debt shelf registration at (P)Ba3; preferred stock shelf registration at (P)"ba3" and the company's rating for commercial paper at Not Prime..
S. S. Kresge Company -- guaranteed industrial development revenue bonds at Ba1.
Kmart Financing I -- Guaranteed Trust Convertible Preferred Securities at "ba3"; preferred stock shelf registration at (P)"ba3".
Kmart Financing II -- Preferred stock shelf registration at (P)"ba3".
Kmart Financing III -- Preferred stock shelf registration at (P)"ba3".
Kmart Financing IV -- Preferred stock shelf registration at (P)"ba3".
Kmart's obligations under the guarantees of the Builders Square leases predate Kmart's 1997 sale of the Builders Square operation to an entity formed by Leonard Green and Partners and the subsequent combination of those operations with the Hechinger Company home center chain. Prior to the 1997 sale, both Builders Square and Hechinger had been challenged by the increasing competition in the home center industry and had suffered poor sales and earnings performance. The strategy behind the combination of the two chains had been to create a chain with greater critical mass and potentially a greater capability to compete in the consolidating home center industry. However, the Hechinger Company filing reflects the continued challenges that Hechinger is having in competing. Should Kmart be called upon to honor its guarantees under the leases, Moody's does not believe the ultimate financial impact of honoring the commitments under the leases will have a significant impact on Kmart.
Kmart's improvement has been demonstrated by improved operating performance and cash flow generation. Kmart's operational improvement is evident across the business. In the areas of merchandising, Kmart's initial roll-out and subsequent line extensions of home products under the Martha Stewart brand has met with resounding success. The Sesame Street children's apparel is likely to be another successful product line and point of differentiation for the company over the long-term. Further, the significant improvement in women's apparel area represents a return to the level of productivity not seen in the women's area since 1996. The company's Pantry concept is appealing to time-starved consumers and assists in boosting sales productivity. These initiatives or successes are indicative of both greater product and customer knowledge and also reflect Kmart's success in beginning to again connect with its traditional customer. On the operations side of the business, the company has continued to reduce its cost structure to a more competitive level and has improved its in-stock level and customer service.
The rapid growth of discount store retailing and the ongoing consolidation occurring in this segment of retailing is raising the bar for all competitors as stronger competitors prosper and weaker competitors fall by the wayside. This trend will continue to pressure Kmart to further increase its sales productivity, improve its systems and logistics, enhance in-stocks, and remain cost competitive. During the last few years, the pricing environment in discount retailing has been relatively benign, giving competitors some pricing flexibility. However, should the economy slow or should Wal-Mart, the pricing leader, decide to increase its pricing aggressiveness to gain share, Kmart could find it more difficult to increase sales or maintain margins. Further, the raising of the competitive bar is requiring that Kmart and its competitors consistently execute strategies effectively if they are to prosper. In the past, Kmart has suffered from poor execution of strategies, such as occurred in the women's apparel area in 1997. Given the tougher competitive environment and the importance of execution, Moody's will continue to consider to what extent there will be consistency and sustainability to Kmart's execution of strategies.
Kmart has achieved solid comparable store sales growth, in part as a result of its roll-out of the Big K format. The company expects to complete the roll-out of this format during the next year. Thereafter, Kmart can pursue a number of different strategies to enhance growth and shareholder returns. As part of the evaluation of Kmart's ongoing credit quality, Moody's will consider Kmart's ongoing financial flexibility, its growth strategies, and any strategies the company could employ to enhance shareholder value and/or achieve further growth or enhance earnings or returns.
Key to any further rating upgrade is whether improved earnings, cash flow, and debt protection measures are consistently sustainable. Integral to achieving that performance over the long-term, Moody's believes, is improvement in merchandising and operations which require enhanced logistics and management information system capabilities. Kmart management has worked both internally and with external consultants to identify the areas requiring attention and investment and these initiatives are a top priority for the firm. Development and implementation of strategies has begun and the company has initiated a search for a new Chief Information Officer. Progress in these areas, Moody's believes, are of critical importance in improving the company's competitive position and thereby its earnings and cash flow.
Kmart Corporation, headquartered in Troy, Michigan, is one of the largest discount retailers in the United States.
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