To The Moon

$Kohl's(KSS)$ is a leading U.S.-based department store chain offering a wide range of products, including apparel, footwear, accessories, home goods, and beauty products. Founded in 1962 and headquartered in Menomonee Falls, Wisconsin, Kohl's operates through a network of stores and a growing online platform.

Key Business Segments

• Retail Stores:

  As of 2024, Kohl's operates around 1,100 stores across 49 states, focusing on suburban areas with large store formats.It is one of the largest department store chains in the U.S., emphasizing value and convenience.

• E-Commerce:

  Kohl's digital sales continue to grow, leveraging an omnichannel strategy that integrates online shopping with in-store services, such as curbside pickup and returns.

• Key Partnerships:

  A notable collaboration with Sephora includes integrating Sephora beauty shops into Kohl’s stores to attract younger demographics and enhance foot traffic. The company plans to expand this partnership further in the coming years.

Earnings & Revenue

KSS recently reported its Q3 2024 financial results. The company posted earnings per share (EPS) of $0.20, which missed analysts' expectations of $0.28. Quarterly revenue came in at $3.71 billion, reflecting an 8.5% decline year-over-year but slightly exceeding the $3.64 billion estimate by analysts.

Net sales decreased by 8.7% compared to the same quarter in 2023. Despite the sales decline, Kohl's managed to improve its gross margin rate slightly to 39.1%, up from 38.9% last year. Comparable sales dropped by 9.3%, reflecting challenging consumer demand. Kohl's attributed some of its revenue decline to a strategic focus on inventory management and efforts to reduce promotional activities.

Performance (Q3 2024):

• Revenue: $3.71 billion, a year-over-year decline of 8.5%. This includes:Net Sales: $3.51 billion, down 8.7%.Other Revenue: $203 million, down slightly from $211 million in Q3 2023.

• Earnings Per Share (EPS): $0.20, missing analysts' consensus of $0.28.

• Gross Margin: Improved slightly to 39.1%, compared to 38.9% in the previous year, due to better inventory management and reduced promotions.

• Comparable Sales: Decreased by 9.3%, reflecting challenges in consumer spending.

Fundamental Analysis

Financial Performance

• Kohl's has faced challenges in recent years, with declining sales and profitability due to shifts in consumer behavior, competition, and economic pressures.

• In Q3 2024, Kohl's reported $3.71 billion in revenue, down 8.5% year-over-year, and an EPS of $0.20, missing analyst expectations

Liquidity & Debt

• Kohl's reduced long-term debt by $113 million, enhancing its financial stability.

• Operating cash flow for Q3 was negative at $195 million but improved to $52 million for the first nine months.

Growth Analysis

Kohl's (KSS) growth analysis highlights its strategic adjustments amidst a challenging retail landscape, focusing on operational efficiency and margin improvement rather than top-line expansion.

Expanding Sephora partnerships and investing in store refreshes could drive future sales.

Strategic cost controls, such as reducing inventory and improving operating efficiency, may enhance profitability in the medium term

Revenue and Sales Trends:

Quarterly Revenue

• Over Q3 2024, Kohl's experienced an 8.5% decline in revenue year-over-year, driven by an 8.7% drop in net sales and a 9.3% decline in comparable sales.

• For fiscal 2024, the company projects a 7-8% decrease in net sales and a 6-7% decline in comparable sales, attributed to weaker consumer demand and reduced discretionary spending.

Margin Growth:

• Gross margin improved slightly to 39.1% in Q3 2024, up from 38.9% the prior year. This reflects better inventory management and reduced promotional activity.

• Operating margins are forecasted to range between 3.0-3.2% for fiscal 2024, down from higher pre-pandemic levels, yet showing resilience in cost control.

Profitability Pressures:

Quarterly EPS

• EPS for Q3 2024 was $0.20, falling short of consensus estimates. Annual EPS guidance of $1.20-$1.50 reflects limited profitability growth.

• Operating income declined year-over-year to $307 million for the first nine months of fiscal 2024, compared to $418 million last year.

Valuation Concerns

Valuation concerns for Kohl's (KSS) stem from its declining sales trajectory, profitability pressures, and an uncertain outlook in a challenging retail landscape. These factors have resulted in a low valuation relative to peers, but the risks associated with its business model and market conditions warrant closer scrutiny.

Key Valuation Metrics

1. Price-to-Earnings (P/E) Ratio: Kohl’s current trailing P/E ratio of approximately 5.8 is significantly below the retail sector average. This reflects:

   Market skepticism about the company's ability to sustain earnings growth amid ongoing sales declines.A possible undervaluation if Kohl's manages to stabilize its financial performance.

2. Dividend Yield: Kohl's maintains an attractive dividend yield of around 13.5%, which can appeal to income-focused investors. However, the sustainability of such a high yield may be questioned if earnings and cash flow remain under pressure.

Market Sentiment

Stock Performance: Kohl's shares have experienced significant volatility, recently dropping 17% in a single trading session. The stock is trading near its 52-week low, reflecting diminished investor confidence. Over the past six months, the stock has declined by over 44%, under performing its sector​.

Financial Trends: In Q3 2024, Kohl's reported a 6.1% year-over-year drop in net sales and a 6.4% decline in comparable sales. Although gross margins slightly improved to 39.4%, the company's operating income fell by 27%, and net income dropped over 50% compared to the previous year​.

Investor Concerns: Analysts and investors are wary of Kohl's declining sales trajectory, increased competition, and strategic headwinds, such as reliance on promotions and challenges in driving foot traffic. However, Kohl's continued its dividend payments, signaling some level of confidence in its cash flow management​.

Investment Thesis

Bull Case

Attractive Dividend Yield:

• Kohl’s offers a high dividend yield (~13.5%), supported by consistent cash flow generation. This makes it appealing for income-oriented investors, assuming dividend sustainability.

Operational Improvements:

• Inventory management and cost controls have improved gross margins (up to 39.4% in Q3 2024). Continued operational efficiency could mitigate the impact of sales declines.

Debt Reduction:

• Kohl’s reduced long-term debt by $113 million in Q3 2024, signaling progress toward strengthening its balance sheet​

Bear Case

• Declining Sales and Traffic:

  Comparable sales dropped 9.3% in Q3 2024, and full-year guidance predicts a 6-7% decline. Persistent revenue pressures question the company’s ability to drive sustainable growth​

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• Macroeconomic Sensitivity:

  Kohl’s core customers are middle-income households, which are particularly affected by inflation and reduced discretionary spending. This could prolong weak demand​.

• Intense Competition:

  Kohl’s faces challenges from e-commerce giants like Amazon and value-driven retailers such as Walmart and Target. Its traditional department store model is losing favor with consumers

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• Execution Risks:

  While the Sephora partnership is promising, its success depends on execution and scale. Similar initiatives by competitors could dilute its impact.

• Profitability Pressures:

  Operating income fell 27% year-over-year in Q3 2024, and full-year EPS guidance ($1.20-$1.50) indicates limited profit growth. Investors may remain cautious until earnings stabilize

Challenges

• Declining foot traffic and comparable sales (-9.3% in Q3 2024) due to consumer shifts toward e-commerce and discount retailers.

• Weak demand for discretionary items amid economic uncertainty.

• Intense competition in both physical retail and online shopping.

Growth Challenges:

• Persistent declines in foot traffic and shifts in consumer spending behavior toward digital and value-oriented retailers remain significant headwinds.

• Limited pricing power in a competitive retail market constrains Kohl’s ability to drive significant revenue growth.

Declining Sales and Consumer Demand

• Comparable Sales Declines: Kohl's has reported a consistent decline in comparable sales, with a 9.3% drop in Q3 2024 and an expected 6-7% decline for the full year.

• Economic Pressures: Persistent inflation and reduced discretionary spending have weighed heavily on Kohl’s customer base, which is largely middle-income consumers.

Competition in Retail

• Kohl's operates in a highly competitive market with intense pressure from e-commerce giants like Amazon and cost-effective retailers like Target and Walmart. Additionally, department stores have faced an overall decline in consumer preference.

Inventory and Cost Management

• While Kohl's has improved inventory management, the decrease in inventory by 3% year-over-year may signal challenges in stocking the right merchandise to drive traffic and sales.

• Rising costs in logistics and labor continue to strain margins despite efforts to optimize operations.

Store Traffic Declines

• Foot traffic to physical retail locations remains weak as consumer shopping behavior shifts increasingly online. Kohl's is adapting through partnerships (e.g., Sephora), but this has yet to fully offset losses in in-store sales.

Profitability Pressures

• Operating income and net profit margins are shrinking, with operating income down year-over-year and Q3 EPS of $0.20 missing analyst expectations.

• Full-year diluted EPS is forecasted at $1.20-$1.50, reflecting modest profitability and limited near-term growth potential.

Long-Term Strategic Uncertainty

• Kohl’s faces challenges in aligning its brand and store offerings with evolving consumer preferences. Its attempts to draw younger, value-conscious shoppers through partnerships like Sephora are still developing in terms of measurable impact.

Potential Upside Risks

• If Kohl’s successfully leverages its Sephora partnership and enhances in-store experiences, it could reaccelerate traffic and sales.

• Improvements in inventory management and cost reductions may provide a foundation for improved margins and earnings stabilization.

Peer Comparison

Kohl’s valuation metrics are notably lower than those of its peers in the retail sector, indicating either a relative undervaluation or an acknowledgment of heightened risk. Competitors with stronger e-commerce platforms and growth trajectories, such as Target or Macy’s, command higher multiples.

Conclusion

While Kohl’s low valuation might appear attractive for value investors, concerns about declining sales, profitability pressures, and competitive risks weigh heavily. The company must demonstrate sustained improvement in margins and growth initiatives to justify a re-rating of its stock. Without clear signs of recovery, the stock could remain undervalued for an extended period.

Kohl’s is a high-risk, high-reward investment. Its valuation and dividend yield make it attractive for value and income investors, but the company faces significant headwinds in sales performance and competition. A compelling case for investment hinges on confidence in management’s ability to execute strategic initiatives, sustain dividends, and navigate the challenging retail environment.

Investors should consider their risk tolerance and monitor upcoming financial results, particularly for signs of sales stabilization and margin improvement. A long-term turnaround could provide upside, but short-term risks remain pronounced.