Kohl's: Early Estimates Haunt the Holiday Shopping Season

In this economic environment, it is increasingly difficult to recommend stocks, but it is even more difficult recommending the purchase of retail stocks. Gloomy forecasts going forward, and a mindboggling recession that could drag on into 2010 predicates fears that the worst is not behind us. Even though this year’s holiday shopping season was longer than in years past, early estimate suggest that retail sales will fall 7-10% this year. While most retailers are feeling the pinch this holiday season, Kohl’s may be the best positioned to weather the storm.

Although Kohl’s Corporation (KSS) has a stellar balance sheet and industry leading valuations, consumer confidence is at a sixty year low. This should send a strong signal for investors to proceed with caution because of the difficulty to formulate projections for fourth quarter 2008 and 2009 earnings estimates. Retailers are slashing prices on everything in their stores, which will undoubtedly impact net margins, profitability and ultimately earnings per share.

That being said, expect Kohl’s to underperform earnings per share estimates due to slumping sales and shrinking margins. In order for Kohl’s to continue growing sales in coming months and beat earnings estimates, they will have to dramatically increase sales volume to compensate for diminishing profit margins. While this scenario is possible, it is very unlikely. Consumers have much less disposable income than they had 3-6 months ago, and those who do are more reluctant to spend it because of the macroeconomic environment. In addition to having less disposable income, credit markets are much tighter, hindering the consumer from obtaining borrowed money or buying on credit.

Compared to its peers, Kohl’s is on the pricey side trading at 10.7 times trailing earnings. This is significantly higher than the industry average of 3.3 and the sector average of 7.09. As a result of its lofty valuation, Kohl’s has considerably more risk than some of its peers who are only trading at 3-5 times trailing earnings. What is perhaps even more striking is the company’s price to sales ratio of 0.63, which is more than 6 times higher than the industry average of 0.1. Another concern I have about the company is the lack of any dividend. This is not a huge concern when the industry average is only 15 cents per share, but it gives investors piece of mind when they are receiving quarterly or yearly dividend checks.

On the bright side, Kohl’s has been averaging a 12.5% growth rate over the last 5 years. This is well above the industry average of 1.52%, which tells you that the company is effectively managing inventory, marketing and selling their products. Meanwhile, the company’s price to book ratio of 1.63 is in line with the industry average of 1.64. Another number than stands out to me is the incredibly high return on assets of 8.36 which is exponentially higher than the industry average of 0.95. The greatest testament of this company’s success is illustrated by its industry leading net margins of 5.77%. This tells us that after taxes, the company is making 5.7 cents for every dollar of merchandise sold. While this may not sound like all that much, this is much higher than the industry average of .67 cents for every dollar of merchandise sold.

My recommendation is hold off on purchasing KSS in the near term, but take a close look at it 6-9 months down the road. This company is one of the industry leaders in retail sales, and I expect a strong recovery when the market capitulates. Due to its impressive net margins, Kohl’s can afford to further reduce costs while still maintaining profitability. The same cannot be said of many other retailers in this sector. However, in this economic environment even great companies like Kohl’s have more downside. Outlook for the first half of 2009 is very grim and I expect Kohl’s sales to fall dramatically in the next few quarters. Consider KSS in the latter half of 2009, but save yourself the stress and hold off buying any stock in the next 6 months.

Disclosure: no positions

Comments

[schnickelfritz:]

Much of Kohl's 12.5% annual growth rate can be attributed to the fact that Kohl's was experiencing a fantastic expansion nationally over the last decade, and approximately on average 75-95 new stores were being opened each year.
The real growth rate must also heavily consider same store sales comps. How does Kohl's rank in SSS with its competition?
With retailers' markdowns ranging from 60%, 70%, and more, what can be done in the first half of 2009 for an encore? Most retailers in this sector are now conditioning the public to expect markdowns in the 60-80% range. How will that mindset impact future margins?
My overall views are not contrary to Mr. Schiro's analysis. I'm only suggesting a history of Kohl's SSS comps could also add additional support of his assessment.

2008 Dec 28 09:10 AM

[jepittman:]

A negative article on a stock in an underperforming industry after a yearlong recession. This is another example of the pervasive negative sentiment that is so prevalent in the investment community. If anything a discerning investor should be at least be considering the above as a contrary indicator.

2008 Dec 28 10:21 PM