How Target Is Eating Kmart's Lunch -- Literally
The comparable store sales decline Kmart suffered in the second quarter is bad news for parent Sears Holdings (SHLD), as it represents a setback for its survive on the cheap strategy. But it may be good news for Target (TGT).
In recent years, Sears Holdings has made modest investments at it namesake and Kmart stores. They might not be enough to turn those chains around but the parent company has bet that it could erode sales declines with a limited cash infusion. Kmart responded with three quarters of improving comparable store sales, those open at locations at least a year, providing the company with some hope even if Sears comps continued to slide.
Softening second quarter results call in question the ability of Sears Holdings to stabilize Kmart sales, never mind sales at the Sears chain. Kmart slipped because of soft sales in food and related commodities. What's odd is that Kmart has been moving away from food operations for years, closing supercenters and essentially freezing development of discount store food operations at a relatively primitive stage.
Food still is important to Kmart in key markets, though, particularly the old-line, densely populated suburbs and urban areas where it operates many stores that have no or limited competition from Walmart (WMT) and major supermarket chains.
Observers are counting supermarket activity and Walmart actions as factors that hurt Kmart food sales in recent months, but no real change has come from those quarters. What has been changing is Target. It has been introducing much more elaborate food operations across all its discount stores and, recently, the P-Fresh prototype, one that includes a full range of perishables including produce and meat.
Target has been adding stores in inner suburbs and cities for years. Food is particularly important in those environments because Walmart and major supermarket operations have not pushed growth there. It may take a few more quarters of observation to confirm that Target is hurting Kmart downtown due to food. If that holds true, however, the Sears Holdings plan to stabilize Kmart may crumble.
If the limited assortment of food that Target offers in its expanded food sets is enough to get its customers to give up Internet enticements, loyalty card points and Jaclyn Smith, Kmart's hold on them is too tenuous to bank on. Conversely, Target's own on-the-cheap plan -- adding food to discount stores rather than expanding edibles operation via bigger, more expensive supercenter -- will gain credibility. That's ironic, as Kmart was first to add comprehensive food operations to discount stores in a format it called a mini supercenter.
Success will encourage Target to build more expanded food stores, further encroaching on Kmart. And, keep in mind, Walmart intends to plow into urban environments with its supercenters in its next major store initiative diminishing Kmart prospects further.
Sears Holdings has restrained investment in Kmart and Sears stores as it paid down debt. Clearing the balance sheet makes the company a more valuable asset for ESL, the hedge fund that controls the retailer and that is headed by Edward Lampert, who also is Sears Holdings' chairman.
If it can stem declines at Kmart and Sears, the company can build enterprise value through recently launched initiatives including licensing out key private label brands such as DieHard to non-competing retailers and signing up more franchisees in ancillary chains such as its auto centers. In both cases, the company adds additional income streams without having to lay down the cash it would need to build new stores or launch major new advertising programs.
Yet, the brands and franchises that Sears Holdings wants to grow are dependent on the main retail business. They were launched and fostered in association with it. Not only that, but declining sales at Sears and Kmart mean less money for the parent company to reinvest in maintaining brands and supporting franchise systems. If those core chains continue to decline, the whole Sears strategy could sink with them.
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