Department Stores Comparison: Kohl's Is A Winner

Summary

• A full analysis covering department store companies, Macy's, Kohl's, Nordstrom, and Dillard's.
• The main objective is to choose a company that is the safest and has the best probability of surviving the long-term competitive challenge.
• This analysis provides a detailed financial and profitable comparison of the above-mentioned companies.
• According to our scoring system, Kohl's Corporation is the clear winner with stable financial conditions, profitability and the best adaptation in crisis.

The department store companies have recently been through hard times, and the future is not promising. I decided to carry out a financial and profitability comparison of some big-name stores like Macy's Inc. (M), Kohl's Corporation (NYSE:KSS), Nordstrom Inc. (JWN), and Dillard's Inc. (DDS). These companies are experiencing financial distress because of one giant company, Amazon (AMZN), who is taking the lead in terms of market share; their market share is declining because of this. The gap in the market left by J. C. Penney Company and other bankrupted retailers give the above-mentioned companies a larger market share. Based on our analysis, if new lockdowns come, Nordstrom would have the biggest probability of bankruptcy. Anyway, Kohl's should be the strongest one from the comparison.

Data by YCharts

In my last article on Macy's and the spending analysis in the Apparel and General Merchandise sector, I concluded that Macy's could be highly undervalued. These measures could be applied to all department stores companies mentioned. The market is pricing it very badly, and the sell-off is unreasonable. But when we adjust the stock price and look for the financial earnings data, we need to ascertain which company is the safest and has tremendous upside potential.

Two general bullish narratives

The first bullish narrative that we can apply to all department store companies is that of the robust spending data in the USA. There are differences in various states, but we could use the same principle for our analysis, as used in the previous article.

The second narrative is the bankruptcy filings for many smaller retailers and J. C. Penney. I will not elaborate on J. C. Penney's business at this point. It is over, and the company will have to offer huge discounts on its products to get rid of its inventory, other assets to fulfill the liquidation process; this should partially satisfy its lenders. The J. C. Penney bankruptcy (and the others) means that there could be a market share of approximately 10-15 billion USD or more per year, which would be split between the four companies under study, as well as Amazon and others. These companies may subsequently gain J. C. Penney's market share. But here is an essential point - to achieve this, consumers must spend money. The next COVID-19 lockdowns could severely impact the level of consumer spending as it is quite possible, that other bankruptcy filings could follow.

Data by YCharts

The reasons for bankruptcies of small retail stores can no longer be attributed to lockdown measures, but rather to low traffic and the permanently closed stores, or the low financial reserves. The trend can be tracked from the following table where it is illustrated that since April, many companies operating in the Department store sector have filed for bankruptcy.

Source: Economic Tracker

Financial analysis

All the companies involved are under a significant risk, but some are under a bigger threat than others. These companies have not performed well during the current COVID-19 pandemic as a result of a massive decline in sales and operating profit. If further lockdown measures are introduced, if the virus re-emerges during the autumn, there could be a problem with liquidity and solvency as there is the probability that the number of cases could rise once again. For this reason, we need to look at the liquidity and solvency parameters.

	Stock price	Working capital per share	Cash to debt (Current)	Debt-to EBITDA (12TTM)	Debt to Assets	Interest coverage (12 TTM)
Macy's Inc.	6.95	2.50	0.16	NEGATIVE	0.49	N/A
Nordstrom Inc.	15.68	-1.51	0.17	29.54	0.61	N/A
Kohl's Corp.	21.65	20.14	0.31	8.41	0.51	N/A
Dillard's Inc.	30.44	30.82	0.10	9.13	0.27	N/A

Click to enlarge

Source: Created by author using data from Gurufocus.

All of these metrics are important. But for me, the crucial weight has the working capital, cash to debt, and the interest coverage ratios.

The working capital illustrates how many current assets are covered by long-term sources. If there is a negative number like Nordstrom has, it means that the company has endangered solvency or its entire existence because part of its non-current assets is covered by short-term capital. Cash to debt is significant if another "block" to the economy should occur. What is harmful and risky for these companies is the Interest Coverage. In this case, all of the four companies mentioned have negative Interest Coverage (12 TTM). These companies do not have enough operating income to service their payment on their debts for the whole year. The companies have a source of income in the working capital, which has been declining for years. The companies which do not have adequate sources of income from their current assets could go bankrupt if lockdown measures are reinstituted.

Financial scoring

	Scoring
Kohl's Corp.	2.75
Dillard's Inc.	2.5
Macy's Inc.	1.25
Nordstrom Inc.	1

Click to enlarge

Source: Created by author.

There is a significant probability that some companies would not survive the impact of new lockdown measures or if a massive drop in consumer spending occurs. The scoring system shows that one of these companies could be Nordstrom as it has the weakest financial position. Kohl's and Dillard's have the best rating, but this does not mean they are safe. It merely implies that they are safer than the other companies mentioned. If Nordstrom or any other retailers go bankrupt, the remaining retailers could split its revenue, and this sector could be more profitable.

Profitability analysis

	Gross margin %	Operating margin %	5-Y OM growth	ROA % (5Y Median)	ROA %	ROIC % (5Y Median)	ROIC %	3Y EBITDA growth	Revenue (3Y growth)
Macy's Inc.	23.6	-17.7	-13.3	5.12	-9.53	7.86	-7.45	-7.4	-1.6
Nordstrom Inc.	24.49	-19.87	-12.2	5.63	-4.65	8.86	-4.6	4.3	1.7
Kohl's Corp.	36.92	-0.32	-6.2	5.11	-0.7	9.36	0	-1.5	0.5
Dillard's Inc.	32.3	-1.95	-19.1	4.79	-2.84	8.81	-2.98	-10.6	-0.4

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Source: Created by author using data from Gurufocus.

The crisis adaptation and digital strategy

	Q1 sales Y/Y %	Q2 sales Y/Y %	Digital strategy growth Q2 (Y/Y %)	Digital sales (% of total sales) for Q2
Macy's Inc.	-45.19	-35.8	53.00	54.00
Nordstrom Inc.	-38.45	-51.9	-5.0	61.00
Kohl's Corp.	-46.47	-22.93	58.00	41.00
Dillard's Inc.	-45.15	-35.21	N/A	N/A

Click to enlarge

Source: Macy's, Nordstrom, Kohl's and Dillard's fillings.

When comparing the companies' performance during the current pandemic, there was a substantial drop in each companies' sales during the first quarter (number comparison based on Y-on-Y changes in sales).

However, to understand how the average consumer developed, where they moved and where they have made purchases, we need to look at the Q2 performance. As there was only a 23% decline in Kohl's Q2 sales, it reflects that the average consumer was there. Nordstrom was severely impacted during Q2, leaving the company in a terrible financial position. However, they had a more profitable position in recent years. The bad news for Nordstrom is that their sales in Q2 declined almost 52%, which indicates that its consumer base transferred to other stores. They (Nordstrom) lost their market share.

If we compare the success of the digital strategy for each company, we get an idea of how each company developed and nurtured relations with customers, old and new. There was a strong demand for Kohl's and Macy's products (probably for Dillard's too) in the online segment, where the growth (year-over-year) for Q2 was significant; 58% and 53% respectively. Both Kohl's and Macy's realized that there is a strong demand for "promoted online products". On the other hand, Nordstrom's online sales declined by 5% in Q2.

According to Nordstrom's last filing:

Digital sales decreased 5% for the second quarter of 2020 and were flat for the six months ended August 1, 2020, compared with the same periods in 2019, primarily due to the Anniversary Sale timing shift that negatively impacted the second quarter by approximately 25 percentage points. By excluding the shift impact, digital sales increased approximately 20% in the second quarter and in the mid-teens range for the six months ended August 1, 2020.

We have no information regarding Dillard's online sales performance because the company did not report any numbers for the online segment in the last filing. If we assume that there was a 35% decline for Q2 in Dillard's sales (similarly to Macy's), we can predict that online sales (% of total sales) would be between 40-55%. For illustration, we will add the most conservative values to our scoring system, as data has not been reported.

The overall conclusion from crisis adaption analysis means that Kohl's is the best performer in the online segment. The company acquired the most customers. We can ascertain this based on information relating to the percentage of total sales. The digital sales were "only" 41% of all sales in Q2, but the digital segment for Q2 growth is close to 60%. The total decline in sales for Q2 is 23%, which makes Kohl's the best performer during this crisis. The stock price does not reflect it. With current "crisis" fundamentals, there is a potential for a 20-30% move in Kohl's stock price. If we consider the overall advantage to other department stores companies (financial advantage or profitable advantage), the upside potential for Kohl's is in the extraordinarily strong double-digit numbers.

Positive insights from this analysis

Here is what the number can tell us. Each company is counting on a strong online performance for the upcoming financial quarters. For a long-term perspective, some of these companies could shine once again. They could reclaim their market share from the big giants as the online segment shows significant signs of improvement. The next positive insight is that companies with many stores could sequentially close their low performing or low profit-generating stores and save cash, save costs or earn money from rentals or partially change its business model to online.

Total scoring

	Financial Position	Profitability Position	Crisis Adaptation	Final scoring
Macy's Inc.	1.25	1.25	3.75	6.25
Nordstrom Inc.	1.0	1.75	2.25	5.0
Kohl's Corp.	2.75	2.0	4.5	9.25
Dillard's Inc.	2.5	1.2	2.75	6.45
Max. Score	7	6	7	20

Click to enlarge

Source: Created by author.

The rating on Seeking Alpha sees that similar.

Source: Seeking Alpha

Honestly, only a few companies could score between 17-20; but if they did, they would be overvalued. Final scoring represents a risky profile of these companies; once this is known, confidence in this sector will decrease because it's dying. There could be significant stock discounts in fair value because the market's pricing is at the "worst". I remain convinced that this sector is undervalued. Many companies have died; this will only strengthen the giants.

Valuation

	P/S	P/FCF	Shiller PE	EV/EBITDA	P/TB	Earnings Power Value	Tangible book per share	Median P/S value
Macy's Inc.	0.11	7.85	3.64	-2.97	2.24	24.06	3.41	30.74
Nordstrom Inc.	0.2	0	5.8	37.22	-33.11	N/A	-0.48	70.86
Kohl's Corp.	0.19	4.83	5.26	9.35	0.67	58.6	31.21	65.7
Dillard's Inc.	0.14	0	4.84	15.65	0.5	140.11	59.11	89.87

Click to enlarge

Source: Created by author using data from Gurufocus

According to Price to Sales and Price to Tangible Book, Dillard's has the best value and has an excellent Shiller P/E ratio and other metrics. For me, the most valuable models right now are Price to Sales and Price to Tangible Book. However, there is also a critical P/FCF ratio, which is negative under Dillard's. It means that the company has a negative free cash flow. On the other hand, if we consider Dillard's strong financial position, it is the cheapest stock from our analysis. There is a higher risk compared to Kohl's business. Kohl's has the best price to free cash flow ratio. This company is the second cheapest for me, but also the safest one.

Conclusion

If I had to choose from these four companies, I would prefer Kohl's. It has the best financial position, which is the most crucial factor for me. This is based on the expectation that there could be another lockdown in the autumn, which could mean a significant drop in consumer spending. There is a huge probability that Kohl's and Dillard's could survive another lockdown. For Macy's, I remain neutral in the long term. Nordstrom, however, has the worst financial position, and I would get out of this stock. Before the lockdown, this company had outstanding profitability within this sector. During the pandemic, however, this company lost its market share, which is apparent as we examine Q2 sales drop.

Kohl's also passed the profitability analysis as the best performer. Since the pandemic, there has been only a -23% decline in Q2 compared with the previous year. These factors reflect that the best opportunity from this sector could be in Kohl's stock, which remains the safest, the most profitable, and the best performing stock. Dillard's takes second place with Macy's not far behind.

If you are considering a minority investment in department stores and want to diversify, my allocation model, for your guidance, would look as follows: 50% stake in Kohl's, 25% stake for Macy's, and 25% stake for Dillard's.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in KSS, M, DDS 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.