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Kmart stock dips after debt is downgraded

Shares of struggling Kmart Corp. tumbled more than 13 percent last week after Moody's Investors Service slashed its rating on more than $4.7 billion of the discounter's debt to junk bond status, saying "it may be some time'' before the retailer can pay down debt and turn around its operations.

Putting even more pressure on its stock, Kmart, which continues to lose ground to larger rival Wal-Mart, reported that same-store sales for December were coming in below plan.

By mid-week, Kmart stock had tumbled by 13.5 percent, or 78 cents a share, to just $5.00 a share from a closing price of $5.78 the prior week. Over the past year, stock in the giant mass merchant has been slashed by almost two-thirds in value, declining by 63.1 percent, from a 52-week high of $13.55 a share.

Triggering last week's steep decline, Moody's Investors Service cut its rating on the retailer's senior unsecured debt to junk status, to a rating of "Ba2" from an earlier "Ba1," citing "the continuing challenge that the company faces in obtaining benefits from its turn-around initiatives and converting these benefits into substantial improvements in sales, profitability and cash-flow generation."

Moreover, said Moody's, "based upon performance in the current fiscal year, the downgrade also reflects the possibility that it may be some time before internal performance and external market conditions improve to the point that a significant de-leveraging is a highly probable event. The negative outlook also reflects the lack of sufficient evidence to conclude that the company's financial performance has bottomed and the potential for further erosion in the company's franchise and credit metrics."

Despite some positive signs, Kmart "has yet to achieve a significant increase in sales," Moody's fretted. "For the first nine months of the fiscal year, comparable-store sales rose by only 0.4 percent. Although it is still early in the process, it is still uncertain whether operating changes are resonating sufficiently with customers to ensure a sustainable long-term improvement in credit metrics."

Worrisome, said Moody's, is that "several major initiatives come with an immediate, negative, financial impact. The decision to reinvest money back into the stores by increasing store payroll is one example." Moody's said it's also concerned "that the launch of Blue Light Always pricing raises Kmart's risk profile, particularly as it follows the events of Sept. 11. If the sales volumes do not materialize as anticipated, then Kmart will have to introduce a pricing structure that may not provide sufficient gross margin to support an expense rate that is higher than [that of] its competitors."

On a more positive note, Moody's observed that "Kmart's new management team has made progress on several key components of its revitalization plan. In-stock positions are up, while unproductive inventory has been removed from the system. The dollar investment in inventory at distribution centers has been reduced in favor of higher in-store inventory levels. Kmart's shrink rate is down, internal metrics of customer satisfaction scores have increased and expense dollars have been redeployed back into the store and away from the home office and non-customer functions. In addition, ceo Chuck Conaway has made a significant effort to change the culture of Kmart to increase accountability and responsiveness to the customer."

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