(FORTUNE Magazine) – OVER THE PAST three years Kmart Corp. has constructed 153 appealing new discount stores and has spruced up or expanded 800 existing ones in a continuing $3 billion renewal program. The titan of Troy, Michigan, has vowed to go head-to-head, up and down the aisles, with Wal-Mart, the brute of Bentonville, Arkansas, or ''those snake oil salesmen,'' as Kmart CEO Joseph E. Antonini refers to his main rival when he gets agitated. To get balance and growth, Kmart has also built a specialty retail group, including Pace Membership Warehouse, PayLess Drug, Waldenbooks, OfficeMax, and Sports Authority. For its efforts, Kmart is second to no one in diversification. Trouble is, it remains second to someone in nearly every critical retail segment in which it competes. The company is not closing the gap between good, which it is, and great, which it is not, and the cost of playing catch-up is rising. Plain and simple, Kmart still doesn't run stores as well as other retailers do, by measures of sales and profits, and in details such as inventory management. The company's discount stores trail Wal-Mart's in sales and earnings by a country mile. Kmart's home-center warehouse chain, Builders Square, is getting drilled by Home Depot, perhaps the best of its kind. Last year Builders Square had sales of $2.4 billion and weak operating profits of $81 million; in the first quarter, profits disappeared. Earnings are flattening at PayLess, a drugstore chain in the Northwest with sales last year of $2.3 billion and operating profits of $113 million. Among membership warehouse stores, Pace, with sales of $4.3 billion, is being dismembered in some markets, having lost $24 million in the first quarter. There are a few stars in Kmart's firmament. Sports Authority, a rapidly growing sporting goods superstore, is primed to hit $650 million in sales this year, up from last year's $412 million. That division may even sell some stock this year to fund its growth. Four new stores called Super K's, a combination of supermarket and discounter, will provide total annual sales this year of $250 million, each producing five times the average revenue for a discount store. But overall the company's profits fell 57% in the first quarter before special charges, and Kmart allows that estimated profits for the second quarter and for the year are being marked down as well. Certainly, it isn't the only retailer to catch a chill this year. Even the vaunted Wal-Mart has hiccupped, and results at Woolworth, Dayton Hudson, and Venture reflect awful weather in February and March, plus the fact that consumers seem to have had glue in their pockets. But Kmart sales haven't warmed with the temperature, while Wal-Mart and Target are enjoying a solid spring and summer. - THE RECURRENT problems are exasperating Antonini, 52, who has little patience for executives whose mental registers come up short by his tally. Unhappily, that might describe much of Kmart's management. While retail consultants call Antonini a ''visionary'' in one breath, in the next they note that he lacks the organization to implement the schemes of his conjuring. One consultant told FORTUNE: ''The driving force of Kmart, bar none, is Joe Antonini. He is No. 1, No. 2, and No. 3.'' And Antonini must concur, as he holds the positions of chairman, CEO, and president, leaving little authority for anyone else. Antonini, who refused to talk to FORTUNE, told shareholders recently that the slowdown is temporary and that the company's renewal program is succeeding. He cited an analysis of a group of stores in ten midsize and large markets that compared modernized with nonmodernized units. In that particular universe, he said, '' 'Look of the Nineties' stores are achieving higher levels of sales and are 35% more profitable -- that's 35%.'' More than half the company's 2,400 Kmart stores now sport the new Nineties look. Kmart can build as good a box as anyone. The company's new discount store format in Auburn Hills, Michigan, for example, is first rate, with a much more spacious, open look, color-coded department signs, a pharmacy, a music store, and a computer that projects store traffic at 15-minute intervals to ensure that the right number of checkouts will be open. Viewed more broadly, though, Kmart's renewal may itself need a renewal. Last year the company invested $1 billion borrowed at an average rate of 7.6% to get a sales increase of less than 4% -- or $922 million -- in its U.S. Kmart division. In fact, Kmart's new-store sales fell last year from $161 a square foot to $147, according to Bernstein Research. Sales per square foot in all Kmart stores, a critical productivity measure, have dropped for three consecutive years. PART OF THAT DROP can be explained by Antonini's strategy of lowering prices on thousands of items, such as health and beauty products, household goods, and consumables like detergents, to become more competitive day to day. But Kmart hasn't been able to convert those lower prices into more loyal customers, in part because Wal-Mart and others will not cede the low ground. ''It's very simple,'' says one Wal-Mart manager grimly. ''We are not going to be undersold.'' Antonini hoped to offset the drop in prices by selling more apparel, which carries higher profit margins. Formerly the director of Kmart's apparel division, he has made that department the cornerstone of his strategy. And the company has received some raves for its more fashionable sportswear and career-wear collections as well as for adding brand names such as Wrangler, Hanes, L.A. Gear, and Brittania. Last year Kmart's storewide operating profit margin increased to 5.8% from 5.6%. Yet this spring, at stores in Ohio and Michigan, bright yellow CLEARANCE signs dominated the apparel departments. Managers gamely suggested that summer is a-comin' in late this year and that the early markdowns on warm-weather items are an attempt by the company to avoid even bigger markdowns later. Guess wrong on apparel, and you lose big time. Kmart guessed wrong last year, as consumers deferred apparel purchases in a harsh economy. The company had to take higher markdowns, a pattern that repeated itself this year when the investment in summer merchandise fell flat. One result is that Kmart has been unable to narrow the huge five-point advantage Wal-Mart has on operating costs. ''What that means,'' says a Wal-Mart executive, ''is that in an all-out price war they'll go broke 5% before we will.'' Worse, some of the specialty chains that were supposed to drive growth are now retrenching. In home centers, for instance, Kmart's Builders Square stores average about $15 million in sales for each 109,000-square-foot outlet. Compare that with Home Depot, whose stores ring up about $40 million in the same cube. Over the past two years Builders Square exited the state of California and the Atlanta and Hartford markets to concentrate on more promising areas. The company has now created a jazzier store with less of a warehouse look. But Home Depot is taking dead aim on San Antonio, Builders Square's home base. A second competitor, Home Quarters, a division of Hechinger, is rolling into Detroit, another critical area. Says one industry executive: ''Builders Square is the weak sister of the warehouse home-center stores. That's not a good position.'' The same can be said for the position of Pace Membership warehouse stores, which are losing money wholesale. Although membership clubs were sales rockets in the late 1980s, the industry has entered retailing's asteroid belt, where store collisions are frequent. Earlier this year Pace disintegrated in Dallas, selling its eight stores there to Sam's Club, a Wal-Mart division. Pace officials explained the sale as a retrenchment from saturated markets, but says another industry consultant who requests anonymity, ''It's a much bigger deal than anyone is making out.'' Pace spent heavily on Dallas locations to dislodge Sam's Club. Its failure raises questions about the company's ability to battle it out in other highly contested markets. Pace also sold out to Sam's in Chicago, Kansas City, St. Louis, and Toledo. Antonini has installed a new management team at the warehouse stores, led by Thomas Grimm, founder of Price Savers, which Pace bought in 1990. Grimm will likely lop off more stores, retreating to markets where Pace has a defensible position. He is working to refocus Pace on business customers, who account for the bulk of sales, and narrowing the number of items Pace carries, to lower costs and improve inventory turns. These myriad problems are prompting Antonini to look elsewhere for sales dollars. He may have found them in Medina and Montrose, Ohio; Jackson, Mississippi; and Charlotte, North Carolina. That's where the company has built the first four of its Super K's, which, at 167,000 square feet, are two-thirds bigger than traditional Kmarts. By offering a full-line grocery store, with fancy specialty departments, pharmacies, video rental kiosks, and a complete discount store assortment, these stores are appealing to a broader audience than Kmart's usual low- to middle-income patrons. Shoppers like what they see. A previous attempt at something similar, called American Fare, was a disaster four years ago because Kmart simply cobbled a supermarket onto a discount store. Super K better integrates the two sides by combining the merchandise where it makes sense -- for instance, baby food with baby clothes, diapers, and carriages -- and by offering low prices. Sales have outstripped projections so far and so fast that Antonini has fallen in love, ordering up to 100 new Super K's for next year alone. Super K employees are having a hard time containing their enthusiasm, because they believe a Super K is everything a traditional Kmart is not: a Wal-Mart killer. But they are also having a hard time dealing with the home office. Super K was developed outside Kmart headquarters, and its culture is different. Employees worry that Super K's communicative, open-management style, called ''no walls,'' will be co-opted by top-down corporate systems. If Kmart builds all the Super K's Antonini now envisions, it may signal a shift away from continued heavy investing in traditional discount stores. Although Kmart officials say it ain't so, the company needs a new strategy. Retailing in the 1990s is evolving into an asset battle, with big players bulldozing money by the ton to build and defend positions. Kmart cannot triumph on this ground with its current rate of return. Antonini is tough, a battler, but he's looking a little punch drunk. It is time he found a fight he can win.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCES: COMPANY REPORTS, WORLDSCOPE CAPTION: KMART Troy, Michigan