S&P; Junks Kmart’s Debt Rating Struggling Retail Giant Calls Decision ‘Severe’

Standard & Poor’s lowered Kmart Corp.’s bond rating to junk status Friday, a move the retailer said was “excessively severe” but unlikely to cause any immediate cash problems.

S&P said it took the action because Kmart had lost significant market share to more efficient and profitable discounters such as Wal-Mart Stores Inc. and the Target chain of Dayton Hudson Corp.

“Despite very significant efforts by a new management team, it is beyond a two-or-three year horizon for Kmart to again generate operating and financial performance measures that represent an investment-grade credit,” the rating agency said.

The announcement came as another discounter, Ames Department Stores Inc., said it would close 17 stores in three states and cut its headquarters staff, eliminating nearly 1,100 jobs overall.

The news also came one day after Kmart announced it had reached agreements with all its banks and other lenders to restructure $548 million worth of real estate debt.

Under previous provisions, those lenders could have forced Kmart to repay the debt immediately once its credit rating fell to junk bond level as it did Friday. Wall Street analysts feared that would have caused an immediate cash crisis and would have forced Kmart to seek bankruptcy court protection.

The so-called “put-back” provisions will be “substantially eliminated” as a result of the new agreements when they are closed next month, Kmart said.

“While we are disappointed with the rating, this action will not interfere with our efforts to effectively pursue a turnaround strategy and explore additional financial alternatives to enhance our liquidity and financial flexibility,” Kmart said in a statement.

S&P said that the bank agreements were a “major positive,” but that Kmart needs to establish a definitive financing plan for the next two years to restore a good credit rating.

The rating agency cut Kmart’s senior debt rating to “BB” from “BBB,” and reduced its rating on Kmart’s commercial paper to “B” from “A-2.” The move affects about $3.4 billion in debt.

The BB rating is one notch below investment grade, making the bonds a speculative investment that is out of bounds for many trusts and investing institutions.

The lower the rating, the higher the rate of interest a borrower must pay creditors to offset the risk. Those rising interest expenses add to operating costs and make it even more difficult for a business to remain competitive.

Retail analyst Joseph Ronning of Brown Brothers Harriman Inc. in New York said he was surprised S&P lowered Kmart’s rating three notches.

“The important thing is they did get these ‘put’ provisions taken care of,” he said.

S&P analysts said they also were worried about a large number of Kmart bonds scheduled to mature in 1997. They said Kmart likely will have to refinance some of those debts and look at other money-raising alternatives.

Kmart has had 11 consecutive quarters of losses or declining earnings. In the past two years it closed hundreds of stores and cut thousands of jobs as part of a major reorganization.

S&P analyst Gerald A. Hirschberg disagreed with some on Wall Street who said Kmart should close hundreds of more stores. Kmart probably will close a few more, but “S&P is not looking for any massive closing,” he said.

Kmart’s new management is “significantly stronger” and has a reasonable turnaround strategy, S&P said. But it said the retail environment remains extremely competitive and Kmart’s ability to execute its strategy successfully is uncertain.

“Although 70 percent of its discount stores have been modernized, profitability of the U.S. Kmart division has declined dramatically over the last three years and margins have suffered because of poor merchandising decisions,” S&P said.

S&P analyst Nicholas D. Riccio said the weak holiday season for retailers was not a factor in the rating decision. Kmart’s holiday sales figures were better than those of many other major retailers.