“If men liked shopping, they’d call it research.”― Cynthia Nelms
Today, we take a deeper look at a well-known retailer. After a pullback, the stock trades for far less than a buyout offer that was rejected by previous management. With a new CEO now on board, a huge dividend yield and recent insider buying, the company popped up on our radar for further research. An analysis follows below.
Company Overview:
Kohl’s Corporation (NYSE:KSS) is a Menomonee Falls, Wisconsin based omnichannel retailer, selling moderately priced private and national branded apparel, footwear, accessories, beauty, and home products out of 1,170 properties in 49 states (Hawaii) and online. More than half of these locations have a Sephora store-in-store concept. Kohl’s opened its first location in 1962 and went public in 1992, raising gross proceeds of $155.4 million at $1.75 a share, after giving effect to three 2-for-1 stock splits. Shares of KSS trade at $19.00 a share, translating to a market cap of $2.1 billion.
The company operates on a 52- or 53-week fiscal year (FY) ending the Saturday closest to January 31st. For the avoidance of doubt, FY22 refers to the 52-week period ending January 28, 2023.
Net sales are spread out amongst women’s (27%), men’s (22%), and children’s (13%) apparel, home products (16%), accessories (13%), and footwear (9%). National brands account for approximately two-thirds of net sales, with the balance Kohl’s private brands. Net sales comprise nearly 95% of total revenue, with other revenue including its own credit card operations and unused gift cards, inter alia.
Pre-Pandemic Baseline
In the five years preceding the pandemic, the company’s operational and financial performances were remarkably narrow. Kohl’s managed anywhere between 1,154 and 1,164 stores, generating total revenue between $19.7 billion and $20.2 billion during FY15-FY19. It generated gross margins on net sales between 35.7% and 36.4% and Adj. operating margins between 6.1% and 7.7%. The only ‘wide’ range came from non-GAAP earnings, which fluctuated from $3.76 a share (FY16) to $5.60 a share (FY18). Owing to solid cash flow generation, Kohl’s reduced its long-term debt from $2.79 billion to $1.86 billion, repurchased $2.73 billion of common stock, and increased its annual dividend from $1.80 a share to $2.68 a share, during this period. The market, no longer interested in retailers with significant brick-and-mortar footprints, compressed the stock’s multiple during this period, as it entered calendar 2020 down 15% from YEFY14 at $50.95 a share, although after considering the dividend, long-term investors realized a nominal 5% total return.
Pandemic
With the pandemic forcing store closures, FY20 was challenging. Net sales decreased 20%, gross margin fell to 31.1%, and non-GAAP earnings were negative $1.21 per share. Kohl’s was compelled to suspend it dividend after making one $0.704 a share distribution in March 2020. Its shares cratered to $10.89 in April 2020, setting the stage for a significant move higher.
Sephora
During its stock’s rebound – on December 1, 2020 – the company announced a partnership with LVMH’s (OTCPK:LVMHF) personal care and beauty products retailer Sephora, in which it would be incorporating 2,500 sq. ft. Sephora stores at the front of 850 Kohl’s properties through 2023. The market initially cheered this move with shares of KSS more than doubling to $64.15 over the following three and half months.
November Company Presentation
Strong FY21
The rally was also abetted by the anticipation of a post-pandemic bounce back, which materialized with the company enjoying record earnings of $7.33 a share (non-GAAP) on nearly pre-pandemic revenue of $19.4 billion in FY21. Its gross margin soared 700 basis points to 38.1% as shoppers, flush with pandemic aid, did not need much promotional incentives to get them out of their houses and shopping. The quarterly dividend was reinstated, albeit initially at a significantly lower level ($0.25 per quarter) as capital was being deployed for the Sephora buildout.
On the Acquisition Block
With the tailwinds from FY21, management predicted FY22 earnings of $7.25 a share (non-GAAP) on revenue of ~$20 billion, with an operating margin of 7.35%. As it turned out, those forecasts were so off the mark, it bordered on laughable. However, easily more appalling to shareholders was the rejection of a $60 per share buyout overture from Franchise Group (FRG) – up 28% from its last trade of $46.84 – in February 2022. Management responded that, “the current expressions of interest which it has received do not adequately reflect the Company’s value in light of its future growth and cash flow generation.” The statement was accurate: in light of Kohl’s subsequent financial performance, Franchise Group’s offer was clearly too generous.
The company was actually dragging its feet for months on the offer in the hopes of finding a better one. There were certainly rumors of other suitors, including a Simon Property (SPG) and Brookfield’s (BAM) $68 a share solicitation in April 2022. With a potential buyout in the offing – all while undergoing a proxy battle led by activist shareholder Macellum – c-suite executives began to exit, and Kohl’s stock began to wane as traffic at its brick-and-mortar locations floundered. After a disappointing 1QFY22 missed Street consensus by $0.11 a share, rumors circulated that the best offer price had been lowered to $50 a share. Either way, any deal officially fell through on July 1, 2022, and shares of KSS stumbled into a mid-20s to low-30s range for the subsequent eight months. Still dogged by activist shareholders, CEO Michelle Gass fled for Levi’s (LEVI) in November 2022.
4QFY22 Financials & FY23 Outlook
At the same time, the company pulled its 4QFY23 guidance due to the uncertain macroeconomic backdrop. Interim CEO Tom Kingsbury was made permanent CEO on February 1, 2023, and he ‘kitchen-sinked’ the company’s holiday season quarter when Kohl’s reported financials on March 1, 2023. Kohl’s lost $2.49 a share (GAAP and non-GAAP) on revenue of $6.02 billion versus a gain of $2.20 a share (GAAP and non-GAAP) on revenue of $6.50 billion in 4QFY21. The bottom line missed Street consensus by a spellbinding $3.46 a share. Kitchen-sinking it meant reducing inventory at all costs – margins be damned. In this endeavor, management was somewhat successful, lowering inventory from $4.87 billion at the beginning of the quarter to $3.19 billion at the end of FY22, only 4% higher than at YE21. For those thinking this was normal inventory build entering the holiday season, the amount of inventory entering 4QFY21 was $3.46 billion, or 29% lower.
As for FY22, Kohl’s lost $0.15 a share (GAAP and non-GAAP) on revenue of $18.1 billion, missing its initial projections by $7.40 a share and ~$2 billion, after making $7.33 a share (non-GAAP) on revenue of $19.4 billion in FY21. Gross margin was 33.2% and operating margin was 1.4% versus 38.1% and 8.6%, respectively, capping a truly horrendous performance versus management’s initial expectations.
The new management team forecasts the company to earn $2.40 a share on revenue of ~$17.5 billion and an operating margin of 4.0% in FY23. It also anticipates spending $625 million in capex, with the largest percentage of outlay earmarked for 250 more in-store Sephora buildouts. That earnings outlook was ~25% below Street expectations, although shares of KSS initially didn’t react to this outlook, remaining in the mid-20s.
Balance Sheet & Analyst Commentary:
With the company realizing cash from operations of only $282 million while spending $783 million on capex (net of real estate sales), $658 million on share repurchases, and $239 million on dividends, balance sheet cash and equivalents plummeted from $1.59 billion at YE21 to $153 million at YE22 while debt remained essentially unchanged at $1.91 billion. Furthermore, Adj. debt to EBITDAR (which also excludes rent expenses) climbed from 2.33 at YE21 to 4.92 at YE22. Management stated that it is committed to the $0.50 quarterly dividend (8.5% current yield) but has suspended share repurchases until the Adj. debt to EBTIDAR approaches 2.5. Kohl’s credit rating took a hit from two major rating agencies during FY22: BBB- to BB+ at Standard & Poor’s in September; and Baa2 to Ba2 at Moody’s in December. Despite the low cash position, the company has $1.4 billion of liquidity thanks to a recently bolstered revolving line of credit.
Since March, eight analyst firms including Goldman Sachs and UBS have issued Hold or Sell ratings on the shares. Only Robert W. Baird ($35 price target) and Deutsche Bank ($30 price target) have maintained Buy ratings on the stock. On average, they expect the company to earn $2.32 a share (GAAP) on revenue of $16.83 billion in FY23, followed by $2.93 a share (GAAP) on revenue of $16.96 billion in FY24.
CEO Kingsbury has a more bullish posture on his ability to turn Kohl’s fortunes around, purchasing 92,500 shares of KSS – after it broke under its eight-month trading range – at $21.82 a share on March 29, 2023.
Verdict:
Kingsbury’s $2 million of optimism notwithstanding, there is plenty of heavy lifting that still needs to be undertaken and the company is facing two major headwinds: the uncertain macroeconomic backdrop, and the secular trend away from brick-and-mortar retail operators. FY21 was the perfect confluence of events for Kohl’s: people with their share of the $4 trillion plus pandemic aid package looking to get out of the house and spend it after being locked down – against a backdrop of low interest rates. It looks as if the new management team is looking to return the company to the pre-pandemic years, albeit with store-in-store Sephora in tow. That goal is going to be difficult to accomplish in the near-to-medium term given the aforementioned headwinds. As such, Kohl’s stock price could have further downside.
The one floor it has is its real estate holdings. In addition to the takeout speculation in FY22, there were rumors of Kohl’s selling as much as $2 billion of its real estate and leasing it back. That strategy buys more time but does little to improve the business model.
Based on management’s commentary and Kohl’s access to $1.4 billion, the dividend actually appears safe for the balance of the year. The revolver does have an undisclosed fixed charge coverage ratio covenant, but management stated that it was compliant and expects to be for the remainder of FY23 without stating specifically what it is. Even though the dividend appears safe, there are too many challenges for Kohl’s to hurdle in the current environment. As such, investment is not recommended despite the high – and apparently safe – dividend yield.
Ordinarily, I would say the stock is a viable covered call candidate below $20. However, given the dismal quarterly results at retailers Home Depot (HD) and Foot Locker (FL) last week, I would hold off on that course until we see Kohl’s first quarter report, which will be out this week.
“Hanging onto a bad buy will not redeem the purchase.”― Terence Conran
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