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Downgrades

Kmart's troubles continue

When it rains it pours, and beleaguered Kmart Corp. was downgraded once again by the nation's two largest debt ratings agencies, Standard & Poor's and Moody's, both citing the retailer's continued weak operations and a resulting lack of financial flexibility.

Adding insult to injury, it was the second downgrade in less than a week from Moody's.

Late last Friday, after the closing bell on the New York Stock Exchange, Moody's accelerated the pace of downgrades when it when it cuts its ratings on $4.7 billion of Kmart debt to "B2," its fifth highest "junk" grade rating, from a previous "Ba2." And it followed that up days later by downgrading the company's lease-backed notes, also to a "B2" rating.

Moody's said it first lowered its ratings "based on continuing weak operating performance and a widening competitive gap against its peers, as well as uncertainty about the prospects of Kmart's franchise longer term and the traction of its turnaround strategy."

Making matters worse, Moody's added, "The rating remains on review for further possible downgrade. The review will focus on management's review of its plans for 2002 and 2003 and the new financing arrangements it puts in place." Moody's said it "will consider the financial impact of management's strategies, the likelihood of these strategies resulting in significant improvement in operating performance and the extent to which some of these strategies increase the company's risk profile during the transition period."

Noting declining same-store sales in December, Moody's said, "Relative to its competition, Kmart's sales results indicate that it is continuing to lose market share to its major competitors. Additionally, Kmart faces aggressive real estate expansion by Wal-Mart, Target and other retailers with superior operations and financial flexibility. Consequently, Kmart faces the prospect of an accelerated erosion of market share and customer loyalty."

Acting in lock-step, Standard & Poor's reduced its corporate credit rating to "B-" from an earlier "BB." That's just one step higher than the "CCC" grade, which would mark the corporation's debt as "highly speculative." Additionally, S&P placed the ratings on credit watch "with negative implications."

S&P said it based its action "on heightened concerns about Kmart's loss of financial flexibility in recent weeks. Kmart's drop in stock price has accelerated substantially since the beginning of 2002. While the company has faced ongoing challenges to its franchise, as reflected in recent operating and financial results, a recent loss of supplier and investor confidence is troubling."

Kmart debt has now been downgraded four times in just eight days, starting with Fitch, which reduced its ratings to a junk-bond "B-" level.

Sears' rating trimmed

Looking for more top-line growth at Sears, Roebuck and Co., the nation's fourth-largest retailer, Goldman Sachs analyst George Strachan modestly trimmed his investment rating on Sears stock to "market outperform," and removed the retailer from the company's recommended list.

While taking Sears down a peg, Strachan still remains relatively bullish, and said in a research note, "Sears remains a dominant hardlines franchise with a solid credit portfolio and compelling cost savings opportunities still ahead; to achieve further multiple expansion, we believe Sears needs to demonstrate top-line growth."

Dillard's could be downgraded

Moody's Investors Service put long-term ratings of Dillard's Inc. on review for possible downgrade "based on continuing softness in the company's profitability and comparable store sales, as well as the challenges Dillard's management faces in significantly improving operating performance."

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