It’s still too early to shop Kohl’s inventory



MarketBeat.com – MarketBeat

Like other department stores, Kohl’s Corporation (NYSE: KSS) hope consumer confidence improves during the Christmas shopping season. The Fed, on the other hand, would rather not see Americans become more positive about the economic environment. This risks inflation heating up again at a time when Chairman Powell and the company are trying to keep it down.

Traders and investors alike are therefore left to decipher when good news is really good for the stock market — or just another reason for the Fed fire extinguisher to raise interest rates.

The latest sentiment survey from the University of Michigan is a good example. A better than expected 59.1 reading showed that consumers are in a better mood. The price increases are moderate and gift offers are plentiful.

This should mean Kohl’s is in for a strong fourth quarter going into 2023, right? Not so fast.

The company still has several challenges to work through that go beyond consumer trust. Although shares have dipped back to within a few dollars of a 52-week low, investors shouldn’t be loading up their shopping cart just yet.

How did Kohl’s perform in the third quarter?

There’s a reason ugly Christmas sweaters are marked down 50%. Kohl’s profit decreased by the same percentage in the 3rd quarter.

Management acknowledged that inflation continues to hit hard. Faced with higher prices everywhere, middle-class households in Kohl’s wheelhouse simply aren’t spending as much. They buy fewer items and switch to brands with lower value.

In a way, the payoff is positive. About a third of Kohl’s sales come from private label and exclusive items that typically have higher margins. These brands outperformed national brands for the second consecutive quarter.

Unfortunately, this has not been enough to help the bottom line due to Kohl’s increasing cost structure. When you operate more than 82 million square feet of retail space, mostly located in shopping centers, leasing, utilities, wages and other expenses can add up. Together with increased shipping costs and promotional activity, the gross margin fell in the 3rd quarter from 39.9% to 37.3%.

What other headwinds does Kohl face?

Kohl’s share of the retail pie has been declining for years. The Amazon effect and the rise of other online stores have made it difficult for the department store to be relevant. Given the accelerated transition to e-commerce brought on by the pandemic, Kohl’s uphill climb has only gotten steeper.

Yes, Kohl’s has an online store and has made improvements in this arena over the last couple of years. The problem is that digital sales are declining when other traditional retailers have strong digital growth that offsets physical weaknesses. Kohl’s digital sales fell 8% last quarter, a significant result because they accounted for nearly 30% of total sales.

The sales mix is ​​also a problem in this economy. With consumers spending more on groceries and other necessities, there is little room left for discretionary purchases. For Kohl’s, that’s a recipe for failure, given that roughly half of all sales come from apparel and another fifth from home goods. Apart from nudist colonies, clothing is undoubtedly important – but when budgets are stressed, existing wardrobes are asked to go the extra mile.

Another big question mark is leadership. CEO Michelle Gass is leaving Kohl’s for Levi Strauss where she is expected to eventually take on the same role. This has created a void that has yet to be filled and an air of uncertainty surrounding the new management team’s strategy. How the new CEO works with activist investor Macellum Advisors is another big matzo ball of uncertainty.

What are Wall Street’s earnings estimates for Kohl’s?

An unexpected management shakeup and a tough economic climate prompted Kohl’s to withdraw its guidance for the fourth quarter and full year. Never a comforting move, especially given the importance of the Christmas shopping period. Consumers may gain confidence, but Kohl’s shareholders certainly won’t.

For the fourth quarter, Wall Street predicts a fourth quarter in a row with lower revenues. Consensus estimates for the next three quarters call for goose eggs, i.e. 0% growth. Annual sales have yet to return to pre-Covid levels, so the lack of expected growth is particularly troubling – and means further loss of market share for the world’s Amazons.

The trailing P/E ratio of 6x might appear to put Kohl’s on the bargain shelf, but this is a value trap. Cost growth, a secular shift to e-commerce and an interim CEO at the helm add up to a lot of uncertainty. The valuation is where it is because a Kohl’s investment carries a ton of risk. Sales have barely budged from 2019 levels, so keeping the stock near pandemic lows makes perfect sense.

Kohl’s board considered a sale in July 2022, but decided that a decline in retail sales and rising interest rates did not add up. Since then, the stock has gone sideways as the market waits for the next potential catalyst. It doesn’t look like M&A will come to the rescue anytime soon, so Kohl’s will likely be a “show me” turnaround for two more years.

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