Kohl's Chugs Along Despite Challenges

Summary

• KSS reports earnings Tuesday. Revenue is expected to fall in the double-digit percentage rates due to knock-on effects of COVID-19.
• Digital revenue rose 25% last quarter. Another strong performance this quarter could prove KSS is turning the corner on digital sales.
• $2.3 billion in working capital should provide a buffer in case the pandemic lasts longer than expected.
• KSS continues to chug along. I rate the stock a hold.
• This idea was discussed in more depth with members of my private investing community, Shocking The Street. Get started today »

Source: Barron's

Kohl's (NYSE:KSS) reports quarterly earnings March 2nd. Analysts expect revenue of $5.86 billion and EPS of $1.01. The revenue estimate implies a double-digit percentage decline Y/Y. Investors should focus on the following key items.

Will Digital Have Another Strong Performance?

COVID-19 brought business to a halt in the first quarter of 2020. It caused Kohl's and several other traditional retailers to temporarily close stores in order to stem the spread of the pandemic. Kohl's furloughed 85,000 store and distribution center associates and some corporate office associates. In October 2020 the majority of furloughed employees had returned to work.

The pandemic also tested the digital platforms of retailers as millions of Americans were forced to shop online. In my opinion, the pandemic amplified headwinds traditional retailers had already been facing. Retailers must compete in a digital world or get left behind. Target (TGT), Walmart (WMT) and Lululemon (LULU) already embraced digital while Kohl's, in my opinion, was trying to play catch-up.

For the quarter ended October 2020 the company reported revenue of about $4.0 billion, down 13.3% Y/Y. The falloff was due to the continued knock-on effects of COVID-19. Comparable sales fell 13.3% for the quarter. Until the economy fully-reopens, comparable sales may continue to deteriorate. Pfizer (PFE) and Moderna (MRNA) have both received Emergency Use Authorization for a COVID-19 vaccine, creating a pathway to reopening the economy. In the second half of 2021 the economy could fully reopen. Kohl's may face headwinds until then.

However, the company's digital platform reported a strong performance, growing revenue 25% Y/Y:

Now let me shift to our third focus area in driving growth, delivering a differentiated omni-channel experience. The COVID-19 pandemic has no doubt accelerated the shift towards digital, and we’ve seen this in our business. Digital sales represented 32% of our total sales this quarter, increasing 25%.

Our stores supported much of this growth fulfilling nearly 40% of the digital sales. Kohl’s is positioned to continue benefiting from this shift. We have an extremely healthy and flexible off-mall store base, a large and growing digital platform and compelling and differentiated omni capabilities which reach our base of 65 million customers.

Kohl's is also making its physical locations more efficient by using them as fulfillment centers. Walmart and Target have been using their stores as fulfillment centers for years. Offering customers the option to shop online and pick up in the store could make Kohl's more competitive against Amazon (AMZN), Target or Walmart.

The back-to-school season and holiday season are typically important period for Kohl's and other retailers. Amid virtual learning, back-to-school season did not provide much of a sales bump for Kohl's. We will find out Tuesday about the impact of the holiday season on the company's sales. Overall, I believe the rollout of a vaccine and the prospects for a growing economy could be the biggest catalysts for Kohl's.

Margins Could Remain Depressed

Traditional retailers have struggled with declining margins for years. The pandemic caused revenue to decline, hurting scale and gross margins. Last quarter Kohl's reported a gross margin of 36%, down about 300 basis points versus the year earlier period. Gross profit on a dollar basis was $1.4 billion, down 14% Y/Y. The decrease in gross margin was driven by increased shipping costs from higher digital sales, slightly offset by strong pricing optimization. SG&A costs were $1.3 billion, down 8% Y/Y; Kohl's reduced stores expenses and marketing costs.

However, SG&A costs declined less than revenue, which hurt EBITDA. EBITDA of $253 million fell 41% Y/Y. EBITDA margin was 6%, down about 300 basis points versus the year earlier period. Declining gross margins and the consistent loss of scale could weigh on EBITDA for the first half of the year. I anticipate falling EBITDA margins until Kohl's can arrest the slide in revenue.

Solid Liquidity

It is important for retailers to maintain ample liquidity to support themselves in case the pandemic and/or recessionary pressures last longer than expected. Kohl's has $1.9 billion in cash, up from $490 million over the year earlier period. Long-term debt increased $590 million to about $2.5 billion. Like several retailers, Kohl's raised debt to shore up liquidity when the pandemic first materialized. Working capital was $2.3 billion, up from $1.7 billion the year earlier period. Working capital appears ample enough to support the company for several more quarters. Kohl's will likely need it as its business may not rebound for a few more quarters.

Free cash flow ("FCF") through the first nine months of the year was $646 million, up from $367 million. Kohl's cut capital expenditures from $678 million in the year-earlier period to $264 million through the first nine months of this fiscal year. This helped buoy FCF and demonstrated management's ability to pull levers to preserve capital. Monetizing working capital is exactly what management should be doing as the business retrenches.

KSS has an enterprise value of $9.5 billion and trades at 4.9x last 12 months ("LTM") EBITDA. The stock has benefited from a melt-up in broader financial markets, driven by low interest rates and the prospects for an effective vaccine to combat the pandemic. EBITDA could remain depressed for the first half of the year, yet the situation could dissipate after the vaccine rollout takes hold.

Conclusion

KSS is up over 60% Y/Y. I believe the stock is fairly valued given the challenges faced by the company. KSS is a hold.

Analyst’s Disclosure: I am/we are short MRNA. 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.

Comments

[Sage Capital]

KSS's new partnership with Sephora (LVMUY) that features 125 prestige beauty brands in Kohl's stores is a brilliant counter to Ulta. Since the Nov. 2020 launch of Ulta Beauty in Target, now we see a neck-to-neck horserace between two mass retailers trying to capture the incremental beauty sale.
The two US big-box department store retailers x beauty chains now work in pairs to maximize their mutual internal synergies while fending off the competition.

Considering challenges to big-box retailers have come from almost every quarter since 2020, requiring significant investments regarding technologies, in-store innovation, private brands, fulfillment, logistics experiences and services, it has been challenging for big-box retailers to focus on everything instead of what they are really good at.

Hence to leverage the top practices from beauty retailing with independent investments, innovations and existing awareness, it makes sense for TGT and KSS to leverage the two beauty leaders Sephora and ULTA to complement their existing beauty categories. Beauty is now the No. 2 product category after fashion.

This latest move by KSS keeps them in the game, providing support for the big run up in stock price in the past year. But as with most big box retailers without a distinctive competitive edge, the jury is still out for the long-term.

[Green Candles]

yeah we're 5x off the bottom on this one. Now a bump from the hedgies. It's a survivor in the Amazon Age. I concur it's a solid hold at this point.