Coming Kmart/Sears Entity Gets Junked
February 14, 2005,
New York — The impending marriage of Kmart and Sears has met with some skepticism from the Big Three corporate credit rating agencies, each of which has assigned junk-bond status to the combined company once the deal goes through, possibly by next month.
Fitch cited “weak operating trends, long-term competitive challenges facing Sears and Kmart, and risks in executing an accelerated off-mall store growth strategy by Sears.” Fitch said the negative rating outlook “considers heightened risk levels throughout the period of integration, during which time there will be meaningful changes to the management structure as well as the companies' merchandising strategies.”
Fitch added, “As the combined company rationalizes its real estate portfolio, it is expected that several hundred existing Kmart stores will be converted to Sears stores. This creates additional off-mall growth opportunities for Sears, though managing that growth will be a challenge. While the company has indicated that it will monetize its excess real estate, the ultimate value of these properties, and when it will be realized, remains uncertain.”
Moody's Investors Service gave the new company its highest junk rating, Ba1, and said it's leaving the rating on review for a possible downgrade.
The agency said the rating “considers the risks associated with integrating and repositioning two challenged retailers in a fiercely competitive environment, as well as the solid credit metrics that will result from this debt-free combination, and the additional financial flexibility provided by its real estate holdings and the $4 billion senior secured credit facility.”
Scoping out the two retailers, Moody's said, “The Sears franchise, while possessing the best hard lines product line in retail, remains challenged by its ongoing inability to craft a cogent soft lines strategy. Kmart, which has made healthy strides since its emergence from Chapter 11, has yet to prove it can compete effectively as a pure retailer in the discount space now unquestionably led by Wal-Mart.”
Moody's said the merger “should accelerate the new company's ability to increase the number of Sears stores in off-mall locations, as well as allowing the two concepts to cross-merchandise their proprietary brands. However, significant square footage for both concepts will still be devoted to soft lines, categories where both have faced challenges and which will continue to face fierce competition from discounters such as Wal-Mart and Target and specialty retailers such as Gap.
“In addition, the integration process, which is never easy, will be further complicated by the level of real estate rationalization that is likely necessary. With combined domestic locations of approximately 3,500, it is clear that combinations and closing will occur, which will magnify the integration risk.”
Standard & Poor's also gave the new Sears its highest junk-bond rating, BB+, saying the rating reflects “an increase in business risk for the combined company, as both Sears and Kmart will continue to be challenged to improve store productivity and profitability. Each business has struggled with intense competition over a number of years from companies like J.C. Penney Co. Inc., Kohl's Corp., Wal-Mart Stores Inc. and Target Corp.”
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