Kohl's: A Good Value At $65

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About: Kohl's Corporation (KSS)
by: Elephant Analytics
Summary

Kohl's has been able to deliver decent comparable store sales growth in 2018, while also improving gross margins.

A slight improvement of comps into 2019 along with stable gross margins result in an estimated value of $75 to $82 per share.

It appears likely to increase its dividend in 2019 as well, continuing its streak of annual dividend increases since it first announced a dividend in 2011.

Leverage remains low, with net debt at around 0.5x EBITDA.

Kohl's (KSS) has been able to string together some pretty solid results since late 2017. In 2018, it has been growing comparable store sales at close to 2% while also improving gross margins. It is in quite good condition for a department store retailer, with modest leverage (net debt at around 0.5x EBITDA), and the ability to generate a significant amount of cash flow.

With its recent share price decline to $65, it appears undervalued even when using fairly conservative valuation metrics.

Positive Comparable Store Sales

Kohl's has managed to deliver five consecutive quarters of comparable store sales growth now, with YTD comparable store sales growth ending up at +2.1%.

Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018 Q3 2018
-2.7% -0.4% 0.1% 6.3% 0.4% 3.1% 2.5%

Note: 2018 comparable store sales include adjustments for the calendar shift, which benefited first half results and are expected to have a negative effect on second half results. For example, Q1 2018 comps ended up at +3.6%, but 3.2% of that was attributed to the calendar shift.

Based on Kohl's commentary, it looks like the calendar shift may have a negative effect of close to 2% in Q4 2018. It appears to expect fiscal quarter comparable sales to be close to flat in Q4 2018, which means that it may get to near +2% after adjusting for the calendar shift. If Kohl's can achieve that in Q4, it will be a strong result against the +6.3% comps from Q4 2017.

Gross Margins And Earnings

Kohl's has also demonstrated good progress with its gross margins, which are up 39 basis points year to date. It will be a bit tougher to improve gross margins in Q4 2018 due to the higher percentage of digital sales during the quarter (and the significant growth rate with digital sales), leading to shipping costs affecting results. Kohl's still appears to expect slightly improved gross margins in Q4 2018 (such as 10 basis points), which would bring its full-year gross margin improvement to the high end of its 25 to 30 basis point guidance.

The improvement in both gross margins and sales is allowing Kohl's to raise its 2018 EPS guidance to $5.16 to $5.36 (or $5.35 to $5.55 excluding the loss on extinguishment of debt). This would be a modest improvement on the diluted EPS of $5.12 that it reported in 2017.

Valuation

It appears that Kohl's is currently on pace to deliver approximately $2.4 billion in EBITDA in 2018 (excluding the loss on extinguishment of debt). It may be able to increase this to around $2.45 billion in 2019 with a combination of low-single digits comps growth, stable gross margins and a low-single digits increase in SG&A.

Kohl's also has only a modest amount of net debt (around $1.2 billion), so at a 6x EV/EBITDA multiple (based on 2019 EBITDA), it would be worth approximately $82 per share. Using a slightly lower 5.5x EV/EBITDA multiple (to reflect the relatively weak sentiment towards department stores), it would be worth approximately $75 per share.

In addition, Kohl's is able to increase its per share value through share repurchases and may be able to add to its EBITDA by subletting some of its space. It also appears capable of generating several hundred million dollars per year in cash flow after dividends and its current share repurchase program levels.

Thus, I would consider $75 to be a fairly conservative valuation for Kohl's despite the general challenges in department store retail.

Conclusion

Kohl's is quite healthy for a department store retailer, having managed to increase its dividend every year since it first announced a dividend in 2011. It appears that it should be able to increase its dividend in 2019 as well.

Kohl's is now managing to achieve modest growth in comparable store sales and gross margins. With a continuation of that modest growth in comparable store sales into 2019, Kohl's should be worth around 15% above its current price while using a fairly conservative valuation multiple.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in KSS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.