Kohl's: Mitigating The Impact Of Regulatory Changes To Credit Card Late Fees

seekingalpha04-27

Regulatory changes to credit card late fees are expected to drive a potential $140 million reduction in other revenue for Kohl's in 2024.Kohl's is continuing to convert private label cardholders to ...

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JillianCain Kohl's Corporation (NYSE:KSS) is dealing with the negative impact of regulatory changes to credit card late fees. These changes may reduce Kohl's credit revenue by over $200 million per year, which is a significant amount given that Kohl's reported $717 million in operating income in 2023. Kohl's expects to offset much of this negative impact with incremental revenues from its co-brand credit card, which it introduced in 2023 and is more widely rolling out in 2024. Thus, if Kohl's reaches its targets, its credit revenues should rebound after reaching a low point in 2H 2024. I currently estimate Kohl's standalone value at $27 to $28 per share, with some potential upside if the regulatory changes are reversed or if Kohl's sees rebounding credit revenues in 2025. Credit Business Kohl's noted that the regulatory changes to credit card late fees are expected to affect its other revenue (which is mostly its credit business) in 2H 2024. The regulatory changes are expected to reduce the typical late fee (for U.S. credit cards in general) from $32 to $8. The changes are expected to go into effect in May 2024, but are facing court challenges as well as potential Congressional action. Kohl's reported $890 million in other revenue in 2023 and appears to expect a mid-teens decline to around $750 million in other revenue during 2024. It mentioned that it is dealing with higher loss rates, but this is partially offset by growth in its co-brand credit card. The decline in other revenue is expected to max out at an annualized rate of around $230 million in 2H 2024. Kohl's is aiming for incremental credit revenue of $250 million to $300 million per year for its co-brand credit card by 2025. Some of this would be already achieved by 2H 2024, but it looks like Kohl's other revenue could stabilize at around $800 million to $900 million per year if it hits its co-brand credit card targets. The state of consumer credit is something to watch given the trending higher loss rates, though. Kohl's mentioned that it converted approximately 0.7 million private label cardholders to its co-brand credit card in mid-2023 and expects to convert close to another 5 million holders later in 2024, with further conversions and new customers expected in 2025. 2023 Results Kohl's delivered 2023 results that were generally in-line or somewhat better than its original guidance. Kohl's provided guidance for net sales to be down -2% to -4% in 2023 and ended up within that range with net sales down -3.4% for the year.          2023 Guidance 2023 Actuals   Net Sales -2% to -4% -3.4%   Operating Margin 4.0% 4.1%   Diluted EPS $2.10 to $2.70 $2.85   Click to enlarge While sales were within the expected range, Kohl's did a bit better than expected in terms of operating margins and earnings per share. Outlook For 2024 Kohl's currently expects its 2024 results to be relatively similar to its 2023 results in terms of sales, while its margins and earnings are negatively affected by the regulatory changes to credit card late fees. That negative impact is expected to be partially mitigated by incremental revenue from its co-brand credit card, as well as improved cost performance. Kohl's guidance for 2024 comparable store sales growth is 0% to +2%, while it expects its operating margin to be 3.6% to 4.1% for 2024. This operating margin is potentially a bit lower than its 4.1% operating margin in 2023. A decrease in operating margin would be due to the projected decrease in other revenue from the regulatory changes involving credit card late fees. The decrease in other revenue is expected to have a 0.8% negative impact on Kohl's 2024 operating margins. Excluding other revenue, Kohl's expects a modest 0.55% increase in operating margins. This improvement in other areas is mainly driven by expected gross margin expansion (of 40 to 50 basis points). Kohl's highlights inventory management and lower freight expense as two items that should contribute to increased gross margins. Kohl's is also aiming for marketing efficiency and labor productivity improvements to help reduce its SG&A marginally year-over-year. Based on Kohl's guidance as discussed above, it may generate around $270 million in net income during 2024, or approximately $2.43 per diluted share. The following table shows Kohl's expected results for 2024.     $ Million   Net Sales $16,590   Other Revenue $750   Cost of Merchandise Sold $10,420   SG&A $5,485   Depreciation and Amortization $765   Interest Expense $320   Income Tax $80   Net Income $270   Click to enlarge EBITDA And Free Cash Flow Thus, Kohl's may generate $1.435 billion in EBITDA during 2024, leaving it with $535 million in free cash flow after its $500 million capex budget and $320 million in interest expense, as well as $80 million in income taxes. Kohl's is paying out approximately $220 million in dividends with its $0.50 per share quarterly dividend, so it would have around $315 million in free cash flow after dividends in this scenario. Kohl's is not planning additional share repurchases until its leverage ratio gets nearer to its 2.5x EBITDAR target. The leverage ratio was at around 3.63x EBITDAR at the end of 2023 and, based on its guidance, this may decrease slightly to around 3.5x at the end of 2024. Thus, it seems likely that Kohl's won't repurchase shares in 2024 and will mainly put its free cash flow towards reducing debt. This could involve paying down its credit facility debt and preparing to redeem its $466 million in 2025 note maturities. Kohl's Long-Term Debt (kohls.com (2023 10-K)) After 2025, Kohl's doesn't have any note maturities until 2029 and that 2029 maturity only involves $42 million in notes. Kohl's will likely want to redeem its note maturities instead of refinancing them, since the debt markets are relatively wary of Kohl's long-term future. Kohl's 2031 notes are yielding a bit over 8% to maturity. Outside its 10.75% unsecured notes due 2025, any refinancing would likely result in a higher interest rate on the new notes. Notes On Valuation At projected 2024 EBITDA levels of $1.435 billion, I estimate that Kohl's is worth approximately $27 to $28 on a standalone basis. This is based on a 3.0x multiple to EBITDA, less credit facility and bond debt (total of $1.74 billion), plus Kohl's cash on hand ($183 million) and the projected $315 million in 2024 free cash flow after dividends. I valued Kohl's at around 3.5x to 4.0x pre-pandemic, but reduced this to around 3.0x after that. A continued lower multiple may be reasonable due to the headwinds from the regulatory changes to credit card late fees as well as rising overall credit card delinquency rates. Kohl's standalone value could increase if the regulatory changes are reversed (in courts or due to Congressional action) or if its co-brand credit card can drive increased credit revenue in 2025. If the regulatory changes are reversed and Kohl's credit revenue approaches $1 billion per year, it could be worth in the mid-to-high $30s if the rest of its business is stable. Kohl's real estate has also been potentially valued at $7 billion to $8 billion before, but Kohl's has been reluctant to substantially monetize its real estate, citing the effect on its operating margins. Thus, I believe it is better to value Kohl's primarily as a standalone business, although its real estate could provide some upside in the future. Conclusion Kohl's is dealing with the negative impact of the upcoming regulatory changes to credit card late fees. It expects to mitigate this through the continued rollout of its co-brand credit card, but still expects other revenues (mostly credit revenues) to be down around $140 million year-over-year in 2024. If it meets its co-brand credit card targets, it may see a 2025 rebound in other revenues to around 2023 levels.  At Kohl's expected 2024 results of $1.435 billion EBITDA (which includes 2024 other revenues down $140 million from 2023 levels) I estimate standalone Kohl's value at $27 to $28 per share, with potential upside from a rebound in other revenues through either a reversal of the regulatory changes or meeting its co-brand credit card targets for 2025.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2430005852"}