Buyer Beware: Retail Stocks May Not Pay Off

By Washington Investing Jerry Knight
Monday, March 7, 2005

With Kmart and Sears preparing for a summer wedding and the nation's two biggest department store groups celebrating their engagement, investors may be tempted to start shopping for retail stocks.

Those in the Washington area will have a close-up view of the action when Federated Department Stores Inc., the owner of Macy's and Bloomingdale's, acquires May Department Stores Co., parent of Hecht's and Lord & Taylor, and Kmart Holding Corp. hooks up with Sears, Roebuck and Co.

Shopping in the region will never be the same. Hecht's most likely will be history, with most of its stores reborn as Macy's, which will become the region's dominant department store. Some Kmarts will turn into Sears stores. Stores will be closed. Malls will be rebuilt. Brand names will disappear.

Among this chaos, investors may find opportunities to try to make money. But be warned: Retail is a business in which profitable investing has been hit or miss.

A prime example: Wal-Mart, the world's biggest retailer and the most successful store in America, has been a lousy investment in recent years. Stock in Wal-Mart Stores Inc. today is worth no more than it was in 1999, though it has moved up and down a lot since then and was a big winner in Wal-Mart's early days. Wal-Mart stock closed Friday at $53.10 per share, in line with its average of $54 since the start of 1999.

Yet Kmart, less than two years out of bankruptcy and still facing a questionable future, has been retailing's hottest stock lately. Since Kmart completed its reorganization in the spring of 2003, its stock is up from $13 a share to its Friday close of $105.01.

No one could have guessed five years ago that Kmart, even then a candidate for Chapter 11 bankruptcy protection, would, at least for a while, be a hotter stock than Wal-Mart, which is why handicapping the outcome of these mergers is so difficult.

The goal of Sears and Kmart is to reinvent mass retailing, creating an alternative to Target Corp. and Wal-Mart. They hope to lure customers with Sears's Kenmore appliances, Kmart's Martha Stewart linens and housewares, and the groceries and drugstore items that Target uses to build continuous traffic.

Sears stockholders are scheduled to vote this month on Kmart's offer of $50.55 a share. Sears stock has traded between $20 and $60 a share over the past five years and was in the mid-$30s when Kmart came along. It closed Friday at $51.86.

There is considerable skepticism in retail circles that Sears and Kmart will be able to pull off their retail strategy, but investors have been betting heavily on the merger for another reason: the vast amount of real estate owned by Kmart and Sears.

Investors assume that if nothing else works, the company can sell its stores and make billions.

Then there's the strategy behind the Federated-May merger: to assemble the first truly nationwide department store group and take advantage of national advertising.

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