INDEX:
I. Market News: Uninspiring Economic Data Dulls Market
II. Heroes: K-Tron, Smithfield Foods, Cyrix, System Software
III. Goats: Orbit, Number Nine, EP Technologies, CrossComm
IV. Investment News: Is It Over for Kmart?
V. Calendar: Monday's Economic Events
MARKET CLOSE
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DJIA: 4769.21, up 6.50
S&P 500: 582.49, down 0.14
NASDAQ: 1012.04, down 2.16
MARKET NEWS
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Some confusing economic data kept the bond and stock markets from moving much today. August wholesale inventories were up slightly, the 14th straight rise, despite a slight rise in sales. Such a pattern suggests that businesses are still not able to move their products fast enough to allow them to maintain constant production levels. But the fact that August's rise was relatively slight may point to a minor rejuvenation in economic growth ahead.
The country's unemployment rate remained constant at 5.6%. While this is generally seen as a positive sign for the economy, the pace of job growth slowed in the period. Manufacturing jobs seemed the hardest hit sector. So, is the economy slowing or growing? Is that Greenspan over in the corner flipping a coin and talking to himself?
HEROES
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K-Tron International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:KTII)") else Response.Write("(NASDAQ:KTII)") end if %>, up $1 1/2 to $7, bucked the recent earnings trend in the market and reported that it expects a third-quarter profit. The company said that the current operations backlog is healthy and that their deliveries to customers have improved. Just what is it that they deliver, though? Here's the press-release description of their business: "K-Tron. . . is a major producer of gravimetric and volumetric feeders, blenders and related process control handling equipment." Somehow, we don't think they're talking about kitchen utensils.
Smithfield Foods <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SFDS)") else Response.Write("(NASDAQ:SFDS)") end if %>, up $4 1/4 to $25 3/4, announced today that it has signed a letter of intent to acquire the common stock of John Morrell & Co. from Chiquita Brands International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CQB)") else Response.Write("(NYSE:CQB)") end if %>. The deal will consist of a $25 million cash payment and $33 million more in SFDS stock. John Morrell & Co. is a pork and processed meats producer, and Smithfield expects the acquisition to complement its current fresh pork and processed meats businesses.
Cyrix <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CYRX)") else Response.Write("(NASDAQ:CYRX)") end if %> rose $2 3/4 to $42 1/2 after formally unveiling its M1 chip. The 6x86 processor is Cyrix's attempt to challenge the dominant market player, Intel's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:INTC)") else Response.Write("(NASDAQ:INTC)") end if %> Pentium processor. In some tests, the M1 competes well with the Pentium 133 and is faster than Intel's next-generation P6, or Pentium Pro chip. Cyrix expects the product to add to earnings in the fourth quarter of 1995.
System Software Associates <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SSAX)") else Response.Write("(NASDAQ:SSAX)") end if %> bounced back $3 1/8 to $38 3/4 today. SSAX shares fell $1 1/2 to $35 5/8 yesterday after the company was panned in Thursday's Wall Street Journal "Heard on the Street" column. The article said that the company may come under pressure as mainframes get replaced by client-server systems. Today, apparently, investors spied a bargain.
GOATS
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Orbit Semiconductor <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ORRA)") else Response.Write("(NASDAQ:ORRA)") end if %> dropped $6 1/2 to $9 after CFO Joe Wai announced that third-quarter revenue and earnings will be disappointing, about $0.10 to $0.12 per share, less than half what the market was expecting. Orbit fell victim to having too many eggs in one basket. With three major customers, Orbit suffered when these businesses required fewer Orbit shipments. The company expects the shortfall to be temporary and not to extend into the fourth quarter.
Number Nine Visual Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:NINE)") else Response.Write("(NASDAQ:NINE)") end if %> lost $4 1/2 to $9 3/4 when it announced that third-quarter earnings would be about break even. Number Nine earned $0.09 in the year-ago quarter. The company cited two reasons for the disappointment: lower sales to its largest OEM (original equipment manufacturer) customer and delayed delivery of video random access memory (VRAM) components. The orders left over from September are scheduled to be shipped this month.
EP Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:EPTK)") else Response.Write("(NASDAQ:EPTK)") end if %>, down $3 1/4 to $12 3/4, verified rumors that it is in merger discussions. EP, which produces minimally invasive catheter-based products, is having a hard time remaining independent. Analysts believe that without a merger, EP will have difficulty competing as a one-product-line company against the larger companies which can supply a number of products to hospitals at a time. With multiple products, the larger companies often bundle them together and offer discounts that a small company like EP can't match profitably. Companies rumored as takeover candidates are Boston Scientific <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:BSX)") else Response.Write("(NYSE:BSX)") end if %> and St. Jude Medical <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:STJM)") else Response.Write("(NASDAQ:STJM)") end if %>.
CrossComm <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:XCOM)") else Response.Write("(NASDAQ:XCOM)") end if %> dropped $2 7/17 to $10 7/8 on news that it won't meet revenue and earnings expectations for the third quarter. The company expects to report sales of about $10 million compared to the $12.8 million it earned in the third quarter last year. CrossComm blamed the shortfall on lower-than-expected sales for some of its new products and on its marketing and sales channel expansion.
INVESTING NEWS: A (Premature?) Obituary for Kmart
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Kmart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:KM)") else Response.Write("(NYSE:KM)") end if %> surprised very few people this week when it pre-announced poor third-quarter earnings. Or, at least, it surprised very few Fools. Forecasting profits "well below" last year's third-quarter earnings of $0.04 a share, they virtually guaranteed another quarter of negative results (unless "well below is measured in percentages, where a mere penny or two would be substantial). As Kmart embarks on its ninth consecutive quarter of disappointing results, investors rest uneasy watching the -12.5% returns that they have suffered since Kmart peaked at $29 in late 1992. "It can't get worse, can it?" they whisper.
Darn tootin' it can.
Kmart has done all the wrong things---possibly the only retailer making more mistakes than Woolworth <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:Z)") else Response.Write("(NYSE:Z)") end if %>. Woolworth at least has the excuse that falsified documents caused them to adjust prior earnings downward; Kmart's own strategy under ex-CEO Joseph Antonini is to blame for its problems. And when it got in trouble, Woolworth at least had the common sense to cut its dividend to save a little cash flow and keep its high growth retail properties (Foot Locker). By comparison, Kmart has maintained a hefty dividend despite the fact that it has negative cash flow from operations (translation: they ain't makin' money) and sold off its best properties (Borders Group, OfficeMax, and The Sports Authority) in a series of public offerings designed to raise the cash needed to upgrade their ailing discount department stores.
The real problem with Kmart is its cost structure, which is manifest in its operating margins. In the last two quarters, Kmart's operating margins have slipped from 26% to 23% while its cost of doing business has remained about the same. The company has managed to keep sales, general and administrative expense increases below the rate of revenue increases, but costs have been rising 50% faster than revenues. In the first quarter of 1995, Kmart's costs increased 12.6% on a revenue increase of 8%. In the second quarter of 1995, Kmart's fixed expenses rose 10% while sales only rose 6%. The slipping margins are tied directly to Kmart's promotional strategy to liquidate its massive $7 billion in inventories in order to pay its bills in a quixotic attempt to maintain market share against rivals like Dayton Hudson and Wal-Mart.
Wal-Mart's gross margins float around 20%, but its lower cost structure allows it to maintain a positive operating margin and a profit margin of 3% compared to Kmart's negative numbers. Dayton Hudson, whose struggling Mervyn's unit pulls down its overall totals, has an operating margin of 25%, two points higher than Kmart's, which allows Dayton Hudson to maintain at least flat earnings. Kmart has gone the road of lower gross margins through discounts and higher cost structures. As a result, Kmart is in a cash flow squeeze that has added almost $800 million in debt over the past two quarters.
Now that Kmart has shed its growth properties, while holding on to the ailing Builder's Square, it is focused almost purely on the discount retailing business. On one side, Kmart is flanked by an 800-pound gorilla called Wal-Mart, which boasted $88 billion in revenues in the past twelve months, compared to Kmart's $40 billion. Wal-Mart continues to chew into Kmart's traditional markets by offering higher quality merchandise, friendlier employees, and cleaner stores, run by a management which looks toward the future. On Kmart's other side lie smaller, more nimble competitors that thrive on even lower operating margins, companies such as Consolidated Stores <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CNS)") else Response.Write("(NYSE:CNS)") end if %>, Dollar General <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:DG)") else Response.Write("(NYSE:DG)") end if %>, and Dollar Tree <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DLTR)") else Response.Write("(NASDAQ:DLTR)") end if %>. These three have about $5 billion in revenues between them and are growing as an aggregate at 21% per year. The pressures on Kmart are immense.
Sure, the 4.1% rise in domestic same-store sales for its general merchandise operations during September eased some investors' minds. But Kmart continues to be plagued by operating difficulties in a tough retail market, and maintains a generous dividend even as it sells its most vibrant subsidiaries to raise enough cash to pay its bills. Investors need to start thinking five years ahead and begin wondering if the intersection of Wal-Mart on one side and Consolidated Stores and its cousins on the other won't squeeze Kmart entirely out of the picture. Value investors beware---the Daily News staff wonders if Kmart will be here long enough to see the hoped-for turnaround.
CALENDAR: Monday's Economic Events
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---13- and 26-Week Treasury Bill Auction
Byline: Befumo/Sheard (MF Templar/MF DowMan)