SUPER K FUTURE IN DOUBT AS SEARS, KMART MERGE

NEW YORK -- The $11 billion merger of Kmart and Sears will result in an expansion of off-mall stores carrying convenience and pantry food items, but the new retail giant doesn't appear likely to remain an operator of superstores that include a full-service grocery component.At the press conference announcing the deal last week, Aylwin Lewis, Kmart's chief executive officer and the newly named CEO

NEW YORK -- The $11 billion merger of Kmart and Sears will result in an expansion of off-mall stores carrying convenience and pantry food items, but the new retail giant doesn't appear likely to remain an operator of superstores that include a full-service grocery component.

At the press conference announcing the deal last week, Aylwin Lewis, Kmart's chief executive officer and the newly named CEO of Retail for the combined Sears Holdings, only told SN he is examining the future of Super K, the Kmart division that operates grocery and general merchandise superstores. "We're down to 55 [Super K] stores. We'll look at it and see how we can leverage it," he said.

The merger, subject to shareholder and regulatory approval, and scheduled to close in March, would create the fourth-largest U.S. retailer with annual sales of $55 billion and 2,350 stores. Larger retailers by sales volume include Wal-Mart Stores, Bentonville, Ark.; Home Depot, Atlanta; and Kroger, Cincinnati, which is expected to generate about $56.2 billion in sales this year.

Officials of the companies said the deal would allow Sears to gain a substantial off-mall presence as it chases growth of competitors Wal-Mart and Target, Minneapolis.

Several hundred Kmart stores would be converted to the Sears nameplate and operate a concept based on the Sears Grand off-mall stores, which include convenience and pantry food items, said Alan Lacy, Sears' CEO and new vice chairman and CEO of the combined companies, which would be based at Sears' Hoffman Estates, Ill., offices.

Retail analysts told SN they don't expect Sears will have the ability or the facilities to conduct a grocery operation right away, and that the larger Super K stores will likely be among those targeted to be changed into the Sears Grand concept. They added, however, that competing with Wal-Mart and Target over the long term may eventually require a renewed commitment to food as a traffic driver.

"I don't think the Sears people feel they are experts in grocery or consumables, and that a number of the stores they get from Kmart will be under pressure in terms of the amount of space in the store to add groceries. So I think it's highly unlikely you'll see a dramatic expansion of food as part of the merchandise offering," Mark Husson, managing director, HSBC Securities, New York, told SN. "But as Wal-Mart, Target and Costco have shown, there's no doubt that food generates traffic, so I think they should be sticking with food."

"These are two big companies that are going to have a lot of decisions to make about real estate and other issues in the near term. So I don't see them being really relevant in the [grocery] space right away," added Jonathan Ziegler, principal at PUPS Investment Management, Santa Barbara, Calif. "Down the road, that might be an opportunity."

Minneapolis-based Nash Finch, which supplies groceries to Kmart, could not be reached for comment.

Lacy said off-mall Sears stores would represent a "trade up" from discounters Wal-Mart and Target, driven by exclusive brands in hardware, appliances and apparel.

Sears has been encouraged by the success of four Sears Grand stores it developed from the ground up over the last year, Lacy said.

The deal was orchestrated by Edward Lampert, the Kmart chairman whose investment arm owned stock in both companies. Lampert will serve as chairman of a board that would include seven officials from Kmart and three from Sears.

Stock in Kmart and Sears soared on the news. Sears earlier last week had been the subject of takeover rumors when it was revealed that New York-based real-estate company Vornado Realty Trust had purchased 8 million shares, or nearly 4% of the company, prompting some to speculate that Sears' real estate was more valuable than its retail business.

A similar sentiment helped Kmart amass a war chest following its emergence from Chapter 11 bankruptcy protection earlier this year. Kmart sold blocks of stores to retailers, including Sears, which purchased 50 of them in July. Lampert said last week the combined company now has the ability to create value greater than the underlying real estate by operating the retail business, although he noted non-core stores would still be sold.