KMART CORPORATION HISTORICAL ANALYSIS Note: All dollar values used in this analysis in relation to the financial statements are in millions unless otherwise noted. Introduction Attention Kmart shoppers, all 180 million of you! Kmart Corporation is the second largest discount retailer in the nation and third largest general merchandise retailer. Kmart’s primary lines of business are name brand and private label general merchandise with approximately 2,161 stores, including 100 Super Kmart Centers. Kmart has a retail presence in all 50 states, Puerto Rico, the U.S. Virgin Islands, and Guam. Kmart owns 110 stores and leases approximately 2,051 stores. Kmart’s primary competitors
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KMART CORPORATION
HISTORICAL ANALYSIS
Note: All dollar values used in this analysis in relation to the financial statements are in
millions unless otherwise noted.
Introduction
Attention Kmart shoppers, all 180 million of you! Kmart Corporation is the
second largest discount retailer in the nation and third largest general merchandise
retailer. Kmart’s primary lines of business are name brand and private label general
merchandise with approximately 2,161 stores, including 100 Super Kmart Centers. Kmart
has a retail presence in all 50 states, Puerto Rico, the U.S. Virgin Islands, and Guam.
Kmart owns 110 stores and leases approximately 2,051 stores. Kmart’s primary
competitors from the discount retail sector include Wal-mart, Target, Shopko and Costco.
From the department store sector, J.C Penny and Sears are the main competitors. The
primary factors in maintaining a competitive advantage are price, quality, service,
product mix and convenience.
Kmart stores are generally one-floor, freestanding units ranging from 40,000 to
180,000 square feet. Kmart’s diversification into specialty retailing brought it close to
bankruptcy in 1995. Restructuring efforts have resulted in the conversion of many older
stores into the Big Kmart format featuring grocery sections, brighter décor and an
expanded selection of merchandise. These stores feature an expanded selection of
merchandise including private labels such as Martha Stewart, Sesame Street, Jaclyn
Smith and Kathy Ireland. In addition, new marketing concepts featuring the TV
celebrities Rosie O’Donnell and Penny Marshall are seen in almost every Kmart
commercial.
The Super Kmart center is a new store prototype for the discount retailer that
features a full assortment of groceries as well as a broad selection of general merchandise
and apparel found at traditional Kmart stores. The offerings include fresh and frozen
food, bakery and meats. There are also one-stop conveniences such as video rental, hair
salons, florists, banking, and one-hour photo processing. The Super Kmart centers are
open 24 hours a day and seven days a week. There were 102 Super Kmart centers as of
1998.
Prior to 1996, Kmart had diversified into specialty retailing and international
operations in Mexico, Canada and Singapore, which nearly put them on the brink of
bankruptcy. During late 1995 and into 1996, they began a company wide restructuring
that included the divestiture of these international operations. Additionally, in 1997
Kmart discontinued operations of several subsidiaries including: Building Square, Border
Group, OfficeMax, Sport’s Authority, Thrifty Payless Holdings, Inc. Coles Myer, Ltd.
and Furr’s/Bishops, Inc.
An additional part of the restructuring effort involved the availability of a private
label Kmart Credit Card to credit worthy customers. The credit card is offered though
Beneficial National Bank USA who now owns the accounts receivables and under the
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terms of the purchase agreement, retains all of the credit risk associated with the credit
card.
Kmart over the last few years have been restructuring their organization and as a
result has become the second largest discount retailer in the nation. This restructuring
has not been without financial cost in their performance. Kmart’s performance over the
1996-1998 period will be examined in detail in the remaining sections of the paper.
Financial ratios are calculated from income statements and balance sheets to
evaluate Kmart’s management of assets to produce revenue. The ratios were compared to
industry averages cited from the Robert Morris Associates (RMA) for the year 1998.
Kmart, Wal-Mart, and Target have captured 80% of the discount retail market share.
Consequently, the upper quartile should be used to analyze Kmart’s financial position.
However, RMA common size numbers generate the median ratios. Therefore, this
analysis uses the median ratios to ensue proper comparison to the industry numbers.
Where RMA data was not available, median peer comparisons from Wal-Mart, Target,
Shopko, Ames and Costco were used provided by Bank of America Retail Peer Analysis
for 1998. The remainder of the paper will examine these financial ratios to provide a
benchmark and trend analysis for Kmart for the fiscal years 1996-1998. (Note: See
Appendix for Tables 1-7 for financial statements and ratio calculations).
Ratio Analysis
Liquidity Ratios
Liquidity ratios measure a firm’s ability to meet its financial obligations. The
overall health of a firm has traditionally been measured by these ratios. The usefulness of
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liquidity ratios is now changing as more companies are holding fewer current assets to
generate revenue. These ratios are still a good measure for this industry because the
discount retail industry does rely on a large amount of current assets to generate revenue.
The meaning of high and low ratios is judged based on the relevant industry norms.
Current Ratio
Current Ratio = Total Current Assets Total Current Liabilities
Items in this table represent percentages of total assets.
Account 1996 1997 1998 RMACash & Equivalents 2.88% 3.67% 5.01% 14.3%Merchandise Inventories 45.11 46.96 46.14 36Other Current Assets 6.91 4.51 4.12 .8Total Current Assets 54.9% 55.14% 55.27% 53.60%Current Maturities of Long-term debt 1.09% .58% .54% 2%Trade Accounts Payable 14.06 14.18 14.45 17.3Accrued Payroll & Other Liabilities 9.09 7.85 9.59 7.9Taxes other than income taxes .97 1.54 1.47 N/ATotal Current Liabilities 25.21% 24.15% 26.06% 33.8%Current Ratio 2.15 2.28 2.12 1.6
The current ratio is a measure of total current assets to total current liabilities.
This indicates a firm’s ability to meet its current obligations with cash, inventories or
other liquid current assets. A high ratio usually indicates that a firm is better able to meet
liability obligations.
Benchmark:
Kmart’s current ratio is 27% above the industry norm. It appears that Kmart is in
a better position to meet its obligations than the industry. The company’s common sized
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statements relative to the industry can explain this relation to the industry. Current assets
are 3% greater than the industry; while the current liabilities are 23% lower than the
industry. Thus, the current ratio is greater than the industry.
A closer look into the elements of the ratio indicates a heavy reliance on
inventory, which is 28% above the industry norm. The company also has in comparison
to the industry low cash balances (64% less). Kmart’s current assets are 3% greater than
the industry. The most significant feature of current liabilities is trade accounts payable
at 16% less than the industry. In addition, current maturities of long term debt of accrued
payroll are less then the industry in relative common-size figures. Thus, the current
liabilities of Kmart are 23% lower than the industry. Although Kmart is carrying
significantly less current liabilities it is also carry much less cash and much more
inventory than the industry.
However, Kmart’s cash management appears to be adequate even with the stated
lower cash balances. In reviewing the cash flow statement, net cash after operations was
a positive $2,011M for fiscal year end 1998. Kmart had adequate cash flow coverage to
pay their current maturities of long term debt, interest expense and income tax expense.
Kmart’s net capital expenditures of $1,113M were also covered by cash flow. Kmart’s
remaining cash balance was $710M for the year 1998. However, it is important to note
that net cash flow operations had been on a 52% decline for the three year period 1996-
1998. In addition, Kmart has a revolving credit agreement of $2.5 billion that provides
Kmart the continued flexibility in their cash management practices.
Taking into consideration both common size and cash flow statements it appears
that inventory management may be the primary problem. As seen later in the inventory
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ratios, Kmart holds above the average norm of inventory resulting in their higher costs of
goods sold. In order to better evaluate Kmart’s liquidity, the quick ratio will be reviewed
below.
Trend:
The current ratio over the last three years has remained stable due to the stability
of the current assets and current liabilities as a percentage of total assets. Current assets
grew 1% while current liabilities grew 2% over the entire period and thus, the 1998 ratio
is somewhat less than the 1996 ratio.
Quick Ratio
Quick Ratio = Cash and Equivalents - Inventory Total Current Liabilities
Account 1996 1997 1998 RMACash & Equivalents 2.88% 3.67% 5.01% 14.03%Trade Accounts receivable 0 0 0 2.5Other Current Assets 6.91 4.51 4.12 .8Total Current Assets less inventory 9.72% 8.18% 9.13% 17.6%Current Maturities of Long-term debt 1.09% .58% .54% 2.0%Trade Accounts Payable 14.06 14.18 14.45 17.3Accrued Payroll & Other Liabilities 9.09 7.85 9.59 7.9Taxes other than income taxes .97 1.54 1.47 N/ATotal Current Liabilities 25.21% 24.15% 26.06% 33.8%Quick Ratio .38 .34 .35 .4
The quick ratio is considered a more accurate measure of a firm’s ability to meet
its current liabilities. In calculating this ratio, inventory is subtracted from the total
current assets because it is the most commonly inflated and least liquid current asset.
Benchmark:
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Kmart’s quick ratio of .35 relative to the industry ratio of .4 indicates that the
company is reliant on inventory to meet its obligations. Kmart’s current assets minus
inventory is 9.13% of total assets in comparison to the industries 17.6%. This reliance
upon inventory to meet current obligation is usually a bad situation. Kmart’s lower quick
ratio compared to the industry can be further explained by the fact that Kmart’s inventory
represents 83% of its current assets, which is significantly higher than the industry
average of 67%.
The current liabilities are lower than the industry and have been discussed
previously in the current ratio. While, the current liabilities is only 23% less than the
industry, the current assets minus inventory is 48% is less than the industry.
Consequently, the quick ratio is less than the industry by 12.5%.
Trend:
The quick ratio over the last three years overall has remained stable due to the
stability of the current assets and current liabilities as a percentage of total assets.
However, with a 6% drop in current assets minus inventory and a 2% increase in current
liabilities, the ratio has slightly declined over the three year period. In addition to
liquidity ratios, asset management ratios will highlight the company’s strengths and
weaknesses.
Management Ratios
Sales Receivable Ratio
Sales / Receivable = Net Sales Trade Receivables
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This ratio measures the number of times receivables turn over in a year relative to
sales. This determines the time between a sale and actual collection. The credit terms
and quality of receivables can be measured using this ratio relative to the industry.
Another way to view this ratio is in the number of days the receivable remains on the
company’s books. This ratio will be discussed with the Days in Accounts Receivable
ratio below.
Days Receivable Ratio
Days Receivables = 365 Sales/ Receivables Ratio
Day’s Receivables ratio tells how many days on average it takes to collect on
sales. If this number is high, it indicates that there are some accounts that are aging and
may never be collected. It may also indicate loose credit policies and poor collection
processes. In some extreme cases, it can reveal poor internal controls and processes in
accounting such as cash collection and reconcilement of accounts. Kmart does not carry
any account receivable due to the sale of their credit card to Beneficial National Bank
USA. According to the terms of the sale, Beneficial retains all credit risk for credit card
receivables. Because of Kmart’s zero trade receivables these ratios are not relevant to our
analysis other than to note that Kmart is atypical of their peers.
Total Current Assets 54.13% 55.14% 55.27% 53.60%Total Current Liabilities 25.21% 24.15% 26.06% 33.80%Net Working Capital 28.92% 30.99% 29.21% 19.80%Sales/Net Working Capital Ratio 7.61 7.66 8.14 12.7
Note: RMA sales data was not input because it was not comparable to Kmart which is one of the top three retailers making up 80% of the discount retail market share.
This ratio provides a measurement of how well working capital, the difference
between current assets and current liabilities, is being utilized within the organization. In
essence this ratio tells us for every dollar of new working capital invested in 1998 $8.12
of sales were generates revenues compared to the industry $12.40 in sales. The long-
term survival of an organization is partially dependent on how well it manages current
operations. The firm must strategically plan for a targeted range of current assets and
plan for their financing.
Benchmark:
The sales/net working capital ratio has tracked below the industry average for the
past three years. The ratio has increased from 7.61x in 1996 to 8.14x in 1998 in
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comparison to 12.7x to the industry. Sales/net working capital ratio is 35.91% lower than
the industry.
Current assets are slightly higher than the industry while current liabilities were
29% lower than the industry standard. As a result, Kmart’s sales to net working capital
ratio is less than the industry. This disparity in current assets and current liabilities
relative to the industry could indicate that financing of current assets may be taking place
with long- term liabilities. As a result of Kmart’s net working capital is 48% greater
than the industry. This large net working capital is driving the ratio down relative to the
RMA industry average.
The working capital of the discount store industry can fluctuate due to seasonal
levels net of trade accounts payable, profitability, and the level of store openings and
closings. Kmart ended 1998 with an increase in its number of stores for the first time in
five years. Kmart’s primary sources of working capital are cash flows from operations
and borrowings under its credit facilities.
Trend:
Sales increased by 7%, while net working capital only increased by.2% for the
1996-1998 period, resulting in an increase in the sales/net working capital ratio.
Assets RatioNote: RMA sales data was not input because it was not comparable to Kmart which is one of the top three retailers making up 80% of the discount retail market share.
This ratio shows the effectiveness of the use of fixed assets in a business to
produce sales. There is not a serious distortion in the yearly ratios from year to year,
which represents fixed assets not being largely depreciated or fixed assets are being
replaced/added at the same rate as depreciation. Surprisingly, the intense use of labor in
this form of business has not affected or distorted the ratios from year to year. When
compared to the industry the ratio is considerably low. This may be the result of an over
investment of its fixed assets or a large amount of leasehold improvements. Since
leasehold improvements can only be depreciated on a straight-line basis and not at an
accelerated basis. If Kmart held a large percentage of leasehold improvements versus the
percentage of buildings, the net fixed assets would be larger than their peers attributing to
the discrepancy in the ratio.
Care must be taken when using this ratio to compare other firms. Inflation may
have caused the values of some of the older assets to be seriously understated. Older
assets may have also been depreciated by a greater amount. The result of such a
comparison is that an older firm who acquired its assets years ago at lower prices may
have a higher turnover ratio of fixed assets. In addition, firms using an accelerated
depreciation versus a straight-line method would have a higher turnover ratio.
Benchmark:
Net fixed assets are 40.4% to total assets while the industry is only 37.5%.
Because of Kmart’s reliance on net fixed assets relative to the industry, the net sales/net
fixed assets ratio is 33.06% lower than the industry.
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Kmart leases 95% of all their facilities while the peers in the industry own the
majority of their facilities. It appears that due to this ownership difference, the peers in
the industry are able to depreciate their fixed assets on an accelerated depreciation
method versus the straight-line amortization on leasehold improvements used by Kmart.
As a result, Kmart’s net fixed assets are higher than the industry as previously stated
above. Refer to above Net Fixed Assets/Tangible Net Worth ratio for further details
regarding Net fixed Assets.
Trend:
Sales increased by 7% while net fixed assets increased by 3.9% over the three
year period. As a result, sales/total net fixed assets has increased over the three year
period. Sales increased faster than Kmart’s net fixed assets is again indicative of Kmart’s
Net Sales/Total Assets Ratio 2.20 2.37 2.38 2.6Note: RMA sales and assets data was not input because it was not comparable to Kmart which is one of the top three retailers making up 80% of the discount retail market share.
Again, this ratio is a measure of management's ability to utilize its assets, in this
case all of its assets. It appears that Kmart is only able to generate $2.38 versus their
industry peers generating $2.60 in sales for every $1 of assets. Thus, it appears that
Kmart is somewhat less efficient. This ratio is slightly lower than the industry average
due to the higher inventory and low cash balances. As stated above an effort should be
made however to increase sales volume to improve the ratio. Another option for
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improvement would be to improve its current asset turnover by improving inventory
management, which will improve its total asset turnover, thus improving the net sales-
total asset ratio.
Benchmark:
The net sales/total assets ratio is 8.46% less than the industry average.
Trend:
Sales increased by 7% while net total assets decreased by 1% over the three year
period. As a result, sales/total net fixed assets has increased over the three year period by
8.18%. With the new Big-K format, sales have increased with the introduction of new
lines. In addition, total assets have decreased slightly due to the other assets listed on the
financial statements. The notes to the financial statements did not include an explanation
as to what is comprised in the other asset accounts, both short-term and long-term.
Coverage Ratios
Coverage ratios measure the ability to service debt from operations.
EBIT / Interest
EBIT/Interest = EBIT____ Interest
Account/Item 1996 1997 1998 RMAEarnings Before Interest and Taxes 2.49% 2.43% 3.24% 5.5%Interest 1.44% 1.13% .87% .5%EBIT/Interest Ratio 1.73 2.15 3.72 12.2
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This ratio shows how well a firm is able to meet interest payments. In 1998,
Kmart’s operating income would cover their interest cost 3.72 times relative to the
industry norm of 12.2 times.
Benchmark:
The EBIT/Interest ratio is 3.72x in comparison to the industry average of 12.2x.
Earnings before interest and taxes has tracked below the RMA average for the three-year
period. In 1998, Kmart’s EBIT was at 3.24% versus the industry average of 5.5%. In
addition, interest has decreased by 39.6% over the past three years. However, interest
expense of .87% for 1998 remains above the industry standard of .5%. With EBIT
significantly below the industry norm of interest near the norm, the coverage ratio is
significantly below the RMA average of 12.2.
Trend:
EBIT increased 30% while interest decreased 39.6% over the 1996-1998 period.
Therefore, TIE increased by 115%. This is further validated by total debt dropping from
57.5% to 50.5% of total assets.
Total Debt / EBIT
Account 1996 1997 1998 Median Peer Comparison
Total Liabilities 57.50% 52.68% 50.85% N/AEBIT 2.49% 2.43% 3.24% N/ATotal Debt/EBIT Ratio 10.49 9.15 6.6 4.3
Total debt to earning before interest and taxes indicates the amount of debt the
company has it relates to the EBIT (operating income). For example, in 1996, Kmart had
$10.49 of debt to every one dollar of EBIT, $9.15 and $6.60 for 1997 and 1998
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respectively. In essence in 1998, it took $6.60 of debt to generate $1 of operating
income. This ratio remains high in comparison to the median peer comparison.
Kmart’s improvement by continued reduction of total liabilities was due to the use
of cash from operations to pay down their term debt, mortgage notes and medium term
notes. This reduction of liabilities was offset by the issuance of Commercial Mortgage
Pass Through Certificates (CMBS) mortgage loans, which are subject to interest and
principal payments with a maturity date of February 2002. Total debt also includes a
$2.5 billion revolving credit agreement; however, no outstandings were reported for
1996-1998. However, the revolving credit agreement allows Kmart to carry much lower
cash balances than their peers.
Debt Service Coverage Ratio
Account 1996 1997 1998Net Income $(189M) $298M $568MDepreciation 654 660 671Amortization 0 0 0Interest Expense 453 363 293Total Cash Available for Debt Service $913M $1,321M $1,532MCMLTD $156 $78 $77Interest Expense 453 363 293TOTAL DEBT Service $609M $441M $370MCash After Debt Service $304M $880M $1,902MDebt Service Coverage Ratio 1.49 2.99 4.14
Traditional Debt Service: Operating Income + Deprec .+ Amort .+ Interest ExpenseCurrent Maturity Long Term Debt + Interest
Expense
Traditional debt service coverage is the measurement of a company’s ability to
service its current maturities of long-term debt and interest owed on that debt. Kmart
debt service coverage of 1.49,2.99 and 4.14 for fiscal years ending 96-98 respectively has
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improved for the last three years. This increase in the ratio is attributed to the large
growth in net income of 213.08% and 108.03% coupled with the decrease in total debt
service of 16%.
Kmart leases 2,051 of their facilities. The terms of the leases are 25 years with
multiple five year renewal options the allows the company to extend the life of the lease
up to 50 years beyond the initial term. The following ratios illustrates the companies
ability to repay their debt taking rental expense or lease expense into consideration rather
than the traditional debt service coverage ratio above.
Note: RMA sales data was not input because it was not comparable to Kmart which is one of the top three retailers making up 80% of the discount retail market share.
The Gross Margin and the Operating Margin both represent a company's ability
to translate sales dollars into profit. These margins are calculated at different stages of
measurement.
The gross margin is the relationship between sales and the cost of product sold.
It is an accurate measurement in terms of the company's ability to control costs of goods
sold. Consideration is given to the company's ability to pass unavoidable price increases
to the customers. In most recent years, Kmart has remained consistent in its gross
margin, but it is substantially lower than the industry standard as seen above. The lower
gross margin can be attributed to Kmart's costs of goods sold being significantly higher
than industry standards.
The operating profit margin measures overall operating efficiency. It incorporates
all expenses associated with the operations of the business. Kmart has been successful at
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improving its operating margin due to controlling operating expenses. Operating
expenses were 19.4% in comparison to 26.9% industry average. Although, the operating
expenses were lower than industry, Kmart’s operating margin of 3.30x remains below
industry average of 5.50x. This again can be attributed to costs of goods sold exceeding
The EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization
to Revenue ratio has become a valuable barometer to a company's success. EBITDA is a
measure of cash flow from the company’s operation. The assumption is that as EBITDA
steadily improves, debt will be repaid and a company's balance sheet is acceptable and
portrays a successfully run business. This ratio shows the raw earning power of the
business.
Kmart has continued to improve this ratio and is .77 from meeting the "median
peer comparison". This comparison is made up of the top six retailers in the industry.
Contributions to Kmart's success in this ratio include better merchandising and improved
inventory management. Consumers are attracted to this form of the retail industry,
because of their value of brand names at discount prices.
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% Profit Before Taxes / Tangible Net Worth
Item 1996 1997 1998 RMAEarnings Before Taxes 1.05% 1.30% 2.37% 5.00%Tangible Net Worth 42.5% 47.32% 49.15% 48%% EBT/TNW Ratio 5.43% 6.52% 11.46% 31.9%
EBIT divided by tangible net worth reflects the rate of return on tangible assets
within an organization. When combined with other ratios, it can be a useful management
tool but is more effective when compared to other ratios that provide a more detailed
analysis. A high number is usually indicative of successful management but may be a
false assumption if degree of capitalization and other factors are not considered.
Benchmark:
Kmart’s EBT is approximately 52.6% below industry average due to the higher
COGS, which also resulted in lower gross and operating margins. The tangible net worth
is 2.4% higher than the industry average. Consequently, Kmart’s %EBT/TNW is
considerably lower than the industry average.
Trend:
Kmart’s EBT/TNW has improved by 111% for the three year period ending 1996-
1998. This large growth has been due to EBT growing115% over the three year period
1996-1998 while TNW has only grown by 16%. However, as stated above Kmart is still
well below the industry norm. The upward trend of this ratio may be partially due to the
corporate goal to get themselves in the position of being able to direct large amounts of
capital into new opportunities without add debt.
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Profit Before Taxes / Total Assets
Item 1996 1997 1998 RMAEarnings Before Taxes 1.05%
$330M1.30%$418M
2.37%$798M
5.00%
Total Assets $14,286M $13,558M $14,166M N/A% EBT/Total Assets Ratio 2.31% 3.08% 5.63% 12.3%
Note: RMA asset data was not input because it was not comparable to Kmart which is one of the top three retailers making up 80% of the discount retail market share.
This ratio is a representation of management's ability to utilize the resources
available. It expresses the ratio of pre-tax returns on total assets.
Benchmark:
Earning before taxes of 2.3% is considerable lower than the industry average.
The low EBT is the major factor behind the EBT/Total Assets ratio being less than the
industry. EBT is approximately 52.6% below industry average due to the higher COGS,
which also resulted in lower gross and operating margins.
Trend:
Kmart’s EBT/Total Assets ratio is trending upward since 1996; earnings before
taxes have increased over the 1996-1998 period by 142% while total assets decreased of
1%. As a result, EBT/Total Assets has been above the industry during this period.
The Sales to Square Foot ratio is a measurement of how efficient the retailer is
using its assets. It gives credit to the designers/architects who design the buildings that
house the retailers as well as to the management and marketing staff who control its
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product presentation. It indicates how effective space, in this case square footage for
selling, is utilized. If the sales per square foot is low relative to other retailers in the same
sector a problem may exist. Some of the factors contributing to this problem are the sales
associate's performance, the customer base or the physical location of the business.
Kmart's numbers in this ratio are impressive in that they have demonstrated
improvements and are presently slightly above the median peer comparison. It appears
they are utilizing their assets effectively; however, their lack of growth overall in the
market may be contributed to their lack of profitability from their product mix. Please
note: the s referred to in the table above denotes selling space per square foot while the
“G” represent gross square footage. For example: Kmart is reporting their selling per
square footage, (only the space used to sell) versus Wal-mart is reporting their
selling/square foot from their gross store square footage. The gross number is including
non-selling space, which inflates Wal-mart numbers in the peer comparison.
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ConclusionThe following table identifies key strengths and weaknesses identified through the
historical analysis of Kmart.
Strengths WeaknessesCash: Kmart is maintaining positive net cash after operations to service their debt. However, net cash after operations has declined 52% over the three year period 1996-1998. The cash position could be views as a strength or weakness.Kmart has a $2.5 billion revolving credit agreement.
Cash: Cash balances are 64% less than the industry. In addition, net cash after operations has declined 52% over the three year period 1996-1998.
Accounts Payable: APDOH is 4.61 shorter than the industry average resulting in Kmart paying 14% faster than the industry resulting in the use of cash of approximately $319.
Inventory: Kmart is carrying 28% above the inventory norm. INVDOH is 17.64 days longer than the industry resulting in a longer operating and cash conversion cycles resulting in the use of cash of approximately $1,222.
EBIT/Interest: EBIT increased 30% while interest decreased 39.6% over the 1996-1998 period resulting TIE increasing by 115%.
Cost of Goods Sold: Cost of goods sold is 16% above the industry average resulting in a lower gross margin of 21.84% in comparison to 32.40% industry average. In addition, the operating margin is affected by cost of goods sold at 3.30% versus the 5.50% industry average.
Sales Growth: Sales growth has improved 7.12% over the three year period 1996-1997.
Sales/net working capital ratio: Sales/net working capital ratio is 35.91% greater than the industry. It appears that Kmart is financing current assets with long-term debt.
%EBT/Total Assets: Earnings before taxes of 2.3% is considerable lower than the industry average. The %EBT/Total Assets ratio is less than the industry. EBT is approximately 52.6% below industry average due to the higher COGS which resulting in lower gross margins and operating margins. Earnings before taxes have increased over the 1996-1998 period by 142%.
Same store sales: Same store sales remained constant for 1997 and 1998 and was lower (4.8x) than the industry 6.5x for 1998.
EBITR/ Interest Expense+Rent Expense: The median peer EBIT margin is approximately 3.9% versus Kmart’s 3.24% margin. The lower ratio in comparison to their peers is attributed to the lower EBIT margin.
Sales/net fixed assets: Sales increased by 7% while net fixed assets increased by 3.9% over the three year period. As a result, sales/total net fixed assets has increased over the three year period.
Income growth: Income grew 201% over the three year period. However, due to expenses associated with divesting subsidiaries, Kmart reported losses for fiscal year ended 1996. In addition, Kmart booked expenses for early retirement programs.
Leases vs. Own: Kmart leases 2,051 and owns 110 of their facilities.
Debt Service Coverage: Debt service coverage is 4.14x for 1998 versus 2.99x. This increase in the ratio is attributed to the large growth in net income of 213.08% and 108.03% coupled with the decrease in total debt service of 16%.
Kmart’s income grew 201% over the past three years due to improved
merchandise assortments and roll out of the Big-K format. Additionally, the absence of a
$114M expense for voluntary early retirement was a contributing factor to the income
growth. Although cash balances are significantly lower than the industry, Kmart appears
to manage their cash position with reported positive net cash after operations for the past
three years.
Kmart’s performance is trending upward for the past three years in comparison to
1995 when they were on the verge of bankruptcy. Sales have continued to increase an
average 7.12% for the past three years. In addition, Kmart has reduced interest expense
through debt restructuring and pay downs of long-term debt. Although Kmart is
improving their debt structure, asset management practices could be improved.
Kmart’s primary weakness is their inventory management practices. As seen in
the analysis and above table, inventory has slightly declined in the past year, however
they are still above the industry average by 28%. In addition, cost of good sold is 16%
higher than the industry. This has resulted in a higher INVDOH by 17.64 days greater
than the industry resulting in an effect of $1,222M. Kmart’s management needs to focus
on examining the problem in inventory management control. Inventory management is a
critical aspect in the discount retail industry because it is their primary source of revenue
generation. In addition, Kmart is paying their trade payables faster than the industry by
4.61 days resulting in a $319 use of cash.
Kmart leases 95% of their facilities. The remaining competitors in the industry
own the majority of their facilities. Because of differences in depreciation methods of
straight-line amortization (leases) and accelerated (owning the building), Kmart’s net
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fixed assets are higher than the industry. Kmart has signed 25 year leases with 5 year
renewable options. It appears the new store opening are being bought, rather than leased,
and are included in the 110 stores owned.
Kmart’s same store sales are also lower than the industry caused by recent store
closings and openings. Kmart has closed many stores, while opening others utilizing the
Super K centers. As a result, Kmart’s ratio has been biased down since the new stores
are not included in the ratio. This discount retail industry ratio subtracts out the current
year sales of the new stores to determine same store sales. This ratio ensures that new
store opening do not inflate store sales figures each year. Therefore, this ratio is a critical
part of historical analysis for the discount retail industry.
This historical analysis provides a financial overview of the companies
performance over the past three years 1996-1998. The main strengths and weaknesses of
Kmart are identified in the above table, which were validated in the ratio analysis
throughout the paper. The fourth stage of this industry analysis project will provide
projections for the next three year period.
We expect Kmart to grow at approximately 6.5% increasing at a rate of 2% each
year. This increase is expected due to the opening of the Big K format stores during the
next three years. Cost of goods sold will continue to increase at the rate of sales also
contributed from the opening of new stores for the next three years. Overall net income
will increase due to the increase in sales, controlled SG&A expenses and the absence of
loss of discontinued operations. The sale of all Kmart’s discontinued operations should
be completed by the end of 2000.
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Due to the sales increase and cost of goods sold and new store openings;
inventory on the balance will increase at the rate of sales. The continued change of
Kmart’s format into the Big-K layout will result in an increase in fixed assets contributed
to the refrigeration equipment and expansion of facilities. Kmart has also entered into a
new revolving credit agreement of $40.6MM for working capital will result in continued
decreasing cash balances. Overall, Kmart is expected to continue to report positive
results for the next three years. The main resources used in this paper were the 1996-
1998 audited financial statements, RMA industry data and Bank of America Retail Peer
Analysis.
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APPENDIX
Financial Statements and Ratios
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Bibliography
Laney, Janice. Bank of America Retail Peer Analysis, 1998. Pgs. 62-70.