NEW YORK (CNN/Money) -
UBS gave Kmart a big vote of confidence on Friday, initiating coverage of the stock with a "Buy" rating after the retailer posted its first profit since filing for bankruptcy two years ago.
UBS is the first major Wall Street firm to initiate coverage of the retailer since it emerged from bankruptcy last May.
"That's right, a buy on Kmart," said UBS analyst Gary Balter. "The 'buy' rating reflects [Kmart's] asset values we believe provide support for the stock at this level. Combined with strong positive cash flow, this implies the stock is undervalued."
Balter also set a 12-month price target of $54 on the stock.
Kmart (KMRT: Research, Estimates) shares rallied in afternoon trading on the Nasdaq, hitting new 52-week highs.
Troy, Mich.-based Kmart filed for Chapter 11 bankruptcy protection in January 2002 after a dismal holiday shopping season. But it emerged from bankruptcy last year with a new management team, 600 fewer stores and much lower debt.
"Kmart is like the phoenix. It's rising up again. I wouldn't be surprised to see one or two more firms pick up coverage of the company," said David Sowerby, portfolio manager with Loomis Sayles & Company, whose firm owns 250,000 Kmart shares.
The retailer thrilled investors last month when it posted a profit for its fourth quarter -- which included the critical holiday shopping period -- of $276 million, or $2.78 per share, compared with a loss of $1.1 billion for the same period a year ago. Additionally, it boasted a hefty cash war chest of over $2 billion.
While its comparable sales -- or sales at stores open at least a year -- declined 13.5 percent for the period, the retailer's gross margins have steadily improved, up 23 percent and 25 percent respectively in its fiscal third and fourth quarters, respectively.
So is Kmart the real deal again?
Balter isn't making any bets on that front -- yet. "This is not a retail turnaround story, it's an asset play," said Balter. "It's harder to see the endgame for this company. We don't think they will become a strong retailer but they have significantly improved their balance sheet."
Added Balter, "Kmart is generating well over $500 million a year in cash flow. They have over $2 billion in cash. That, combined with their real estate value, should provide higher support for the stock."
Richard Hastings, retail analyst with Bernard Sands, agrees. "The company is showing stable business improvement and there's a higher probability the stock will shoot higher in the near-term."
Indeed, Kmart appears to be focused not just on boosting revenue growth but improving profitable sales. It has kept inventories low over the past year to avoid clearance sales and push more merchandise at higher prices.
"Kmart vendors are giving more positive comments than a year ago," said Sowerby. "In the past, people who did business with Kmart, said the company's management and distribution was more challenged than it is today."
Last year, Kmart debuted the Thalia Sodi brand of clothing, accessories and home decor in an effort to court a younger urban ethnic market.
Nevertheless, both Balter and Hastings say the long-term forecast for Kmart is still foggy.
"Their lack of investments in systems, continued new store growth by Wal-Mart and higher prices point to short-term cash maximization, not long-term growth," said Balter.
Kmart could not immediately be reached for comment.
--analysts interviewed do not personally own shares of the company and their firms do not have an investment banking relationship with Kmart.
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