Martha Stewart Living Omnimedia’s shares surged on optimism that Kmart Holding Corporation’s proposed purchase of Sears, Roebuck & Company will expand distribution of Martha Stewart housewares and increase sales.

The stock rose $1.09, or 6.26%, to $18.49 in New York Stock Exchange composite trading yesterday. The shares traded as high as $20.94. Kmart sells housewares bearing Martha Stewart’s name and pays the company royalties.

Martha Stewart’s merchandising unit is the company’s second-biggest by revenue, accounting for almost a quarter of the company’s $127.2 million in sales for the first nine months of this year. The shares have risen 77% this year through yesterday as investors bet its founder will improve sales after serving five months in jail for obstructing justice. “In theory, you can open up the whole Sears chain to Martha Stewart’s products,” said Ivan Feinseth, director of research at New York-based Matrix USA LLC, which rates Martha Stewart shares as “strong sell” and doesn’t own them. “The company still has not demonstrated in the near term than it can make any money. It still has losses projected out for the next year.”

New York-based Martha Stewart Living had merchandising revenue of $29.7 million through September 30, compared with $31 million in the same period a year ago. In the third quarter, merchandising sales fell to $8 million from $8.85 million. Most of those sales come from Kmart royalties.

Third-quarter profit widened to $15 million as advertising sales plummeted. The company last month forecast a loss of about 20 cents a share for the fourth quarter.

In April, Kmart extended its contract to sell Martha Stewart Living housewares by two years, through January 2010. Kmart will pay Martha Stewart a minimum royalty of $49 million for the period of February 1, 2004, to January 31, 2005, according to a regulatory filing.

The payments are expected to rise to $54 million by January 2006, $59 million by January 2007, and $65 million by January 2008, according to the Securities and Exchange Commission filing.

Martha Stewart Living named former ABC executive Susan Lyne as president and chief operating officer on November 11, replacing Sharon Patrick. A company spokeswoman, Elizabeth Estroff, didn’t immediately return a call seeking comment.

Standard & Poor’s yesterday upgraded Martha Stewart Living shares to “sell” from “strong sell” saying the Kmart acquisition has “favorable implications” for the media company.

Martha Stewart’s stake of about 30 million shares in the company rose to $554.7 million. Stewart controls 94% of the voting power of the company, according to a Securities and Exchange Commission filing.

Shares of other suppliers to the retailers are also benefiting from the merger announcement.

Danaher Corp., maker of Sears Craftsman tools, increased $1.38 to $58.41 in New York Stock Exchange composite trading. Whirlpool Corp., the second-largest home-appliance maker, rose $2.90 to $66.43.