AGGRESSIVE INVESTORS MIGHT CONSIDER STOCK FROM KMART

The corporate war cry of the 1970s and 1980s was "diversify, diversify, diversify ..." Many tried it and found the strategy to be disastrous. Kmart, with common stock trading on the New York Stock Exchange under the symbol KM, has "been there, done that." The new plan is "focus, focus, focus..." on the primary business, discount retailing. The plan seems to be in place, and this stock may offer a good opportunity for the coming year.

In 1897, partners John McCrory and Sebastian Kresge opened five-and-dime stores in Memphis and Detroit. The partners split two years later. The Detroit-based store was the foundation for Kresge Co., which was incorporated in 1912 and became Kmart in 1977. The Memphis-based store was the foundation for McCrory's, a chain that later bought the last of Kresge's five-and-dime format stores.

The second largest dime store in the United States, Kresge Co. expanded rapidly for several decades. The company formed a subsidiary to operate stores in Canada in 1929 and in the late 1920s and 1930s began to focus on suburban shopping centers. It became one of the largest general merchandise retailers in the United States in the 1950s and entered discount retailing in response to a 1958 marketing study.

The company opened the first Kmart and Jupiter discount stores in the early 1960s. The Kmart format was successful and grew rapidly during the 1970s, and the company changed its name to Kmart in 1977. Diversification was the name of the game in the 1980s, and this company joined the crowd.

During the 1980s, a number of acquisitions were made, and remaining Kresge and Jupiter stores were sold to McCrory's. The acquisitions included Walden Book Co., Builders Square, PayLess Drug Stores, Northwest and Canadian retailer Bargain Harold's Discount Outlets. By the end of the decade, the company was in the warehouse club business with Macro, which it merged with PACE Club.

Acquisitions and international expansion were continued during 1990, 1991 and 1992. Kmart acquired Sports Authority, a majority of OfficeMax in 1991 and OfficeMax acquired Bizmart in 1992. At the same time, there was expansion into Czechoslovakia and Mexico.

The turning point came in 1994. With falling earnings, the company spun off OfficeMax and Sports Authority and sold its small stake in Coles Meyer. It sold residual holdings in OfficeMax and Sports Authority in 1995 and spun off Borders Group (acquired in 1992) to raise cash to remodel existing stores. The architect of the failed diversification strategy, Joseph Antonini, was replaced by Floyd Hall as CEO in 1995.

Hall continued the sell off with a majority of Kmart Canada in 1996, the Czech and Slovakian operations and Builders Square. Under his leadership, the company has formulated plans to focus on making Kmart stores places you want to shop with the labels you want to buy.

What about Kmart stock? Three times during the past year it has traded between $10 and $11 and twice over $14. As I write, it is between $11 and $12. Annual earnings have not turned positive yet, so P/E is not a particularly good measure of value. My other research suggests Kmart should be trading around $30, but that does not recognize a 1996 issue of convertible preferred stock. If the preferred stock is converted by its holders, the value of the common stock would be less than $30.

If you are an aggressive investor, there may be a good opportunity in Kmart, which you could take advantage of in either of two ways. You could buy the stock outright and expect it to return to the $14 to $15 range during the next year, or you could buy the preferred stock. The preferred stock is priced between $51 and $52, has been over $58 twice in the past year and pays a dividend of about 7.5 percent. This preferred stock can be converted to 3.33 shares of common stock at a price of $15.

I do not own any Kmart stock, but I think the preferred stock strategy offers good value and income. If the common stock comes back the way I think it should, the preferred stockholder will have good dividend income for the holding period and an opportunity to convert to common stock when the common stock price exceeds the $15 conversion price. There is some risk in either strategy, but those who are willing to take it may find Kmart to be worth the risk for the next year or so.

Dividend Reinvestment Plan: Yes

Web Site: http://www.kmart.com

Bill Walker is president and CEO of Walkrich Investment Advisors and completes a market appraisal of over 5,000 common stocks each week. (573) 651-9196 (walkrich@mvp.net)

The Southeast Missourian does not recommend that readers buy or sell stocks featured in this column, which is provided for informational purposes only.