Description

KMRT is the CHEAPEST large cap publicly traded retailer. KMRT emerged from bankruptcy in last April. Since emergence it has reported three quarters and provided an update on the holiday selling season. The current valuation is as follows:

Market Cap: $3,074mm
Debt: $470mm
Cash: $1,800mm
Enterprise Value: $1,744mm

Through December of 2003 (fiscal year ends January 2004), KMRT has generated EBITDA of approximately $530mm. Assumming no contribution from January, KMRT is trading at only 3.3x EV/EBITDA. This level of EBITDA is significantly above the $427mm target laid out in the bankruptcy plan. In addition, YTD capex has only been $65mm vs. $450mm indicated in the plan. As a result free cash generation has been significant boosting the net cash position to over $1.3bn as of year end.

A lot of skepticism seems to result from the lack of communication from the company. In fact, KMRT has not hosted a conference call since emerging from bankruptcy last year. As a result, the company's strategy to compete seems unclear. In speaking with former employees, once tactic may be to leverage its locations. Them remaining KMRT stores are generally closer to town centers than WMT. KMRT may attempt to charge higher prices in exchange for the convenience of its locations. Proper merchandising will obviously be a key determinant in the pricing strategy. KMRT may try to stock higher turn convenience items much like the front-end merchandising of drugstores to drive higher prices and traffic. In addition, KMRT seems to be focused on boosting it exclusive lines. The best example is the line of Martha Stewart home goods (the fate of this line given recent events is definitely a risk). KMRT has also developed an apparel line around the Latin singer Thalia. KMRT recently hired two merchants from GPS to help this effort.

This skepticism is obvious in the current short interest. Of a float of 90mm shares, about 10mm are short, representing a short interest ratio of 16.5. When there is more visibility, the high short interest will result in signficant latent buying demand.

In terms of liailities, the other balance sheet items to consider are pension and capitalized leases. The pension obligation is currently stated on the balance sheet at about $800mm. Given the move of the stock market last year, the obligation will probably carry on the balance sheet at a much lower value when it is updated. In any case, the actual cash contrbituion will only be $100-150mm per year. In addition, there are capitalized leases amount to about $400mm (but rent expense is considered in EBITDA).

KMRT's enterprise value of $1.7bn is only 7% of its revenue base of $25bn. Without the burden of debt and a substantial cash balance, it seems that purchase of the stock at these levels provides significant optionality on improving margins. A 2% operating margin (which was the target for 2005 in the bankruptcy plan)would result in EBITDA of $700mm, making the current valuation even more compelling.

KMRT seems to be a misunderstood situation. There are other retailers (grocery stores, etc.) that face signficant WMT competition but trade at much higher multiples. Across retail, there are also weaker #2 or #3 players that command higher multiples (for example CC, which continues to lose share to BBY, has about the same enterprise value but on a sales base of only $10bn and no earnings). The current value will be enhanced once management provides clear strategic direction and begins communicating with the investment community.

Catalyst

Q4 conference call estimated to be on March 24. This will be the first earnings conference call since emerging from bankruptcy.