Kohl’s (NYSE:KSS) has been flying high this week. Shares of the Wisconsin-based retailer have been up 9% over the past three trading days, despite the broad market having moved lower during the same period.
The reason for bullishness has been the company’s disclosure of its new vision and strategy: “to be the retailer of choice for the active and casual lifestyle”, and also to ride the momentum in beauty, digital and innovation.
To be clear, simply having a plan is very different from successfully executing on it. However, I believe that Kohl’s initiatives give the retailer a better chance of surviving the COVID-19 crisis and thriving in the longer term. In this article, I will explain why I no longer side with the bears on this stock, and “upgrade my views” on KSS to neutral.
It wasn’t working
Before looking at Kohl’s plans, it may help to revisit my bearish stance on the retailer, which I have held since August 2019.
Until as recently as a couple of months ago, the company had provided little evidence that the business fundamentals had been improving meaningfully, given what I estimate to be 40%-plus decline in physical store revenues in the second quarter and sharp YOY gross margin compression of more than five percentage points (see table below). The management team had quite a bit to do to turn things around, including a full revamp of the product assortment, particularly on the apparel side.
Source: 2Q earnings slides
The task seemed overwhelming amid a highly disruptive health and economic crisis. Kohl’s recovery looked like an uphill battle to me, given macro-level forces that have been highly unfavorable to department stores across the board. This was particularly true of business models like Kohl’s, which have relied more heavily on the brick-and-mortar channel – I estimate e-commerce to generate a smaller proportion of Kohl’s total revenues compared to peers Macy’s (NYSE:M) and Nordstrom (NYSE:JWN) – and, to a great extent, women’s fashion.
Kohl’s had to change
The company’s new plan is comprehensive, and I believe that it had to be. Among the key initiatives on the retailer’s plate, a few stand out:
- push active wear to account for at least 30% of sales, up from 20% in 2019
- increase online assortment in active wear, while tightening inventory across the departments
- reorganize the women’s department, including a reduction of 40% in “choice counts” in 4Q20
- triple sales in beauty while increasing store footprint allocation
- focus on “omni experiences” (e.g. curb pickup, Amazon Returns, etc.)
Should Kohl’s be successful in its transformation, the company expects to see a return to revenue growth, after a soft 2019 and disastrous 2020, and op margin to reach as high as 8% (see below). To be fair, these goals might not even be enough to push the retailer’s EPS back to 2018 levels, considering the company’s more leveraged balance sheet in 2020. Yet, Kohl’s might not need to “return to its former glory” in order to unlock quite a bit of shareholder value, given how low valuation multiples have been lately.
Source: company’s 8-K
No longer a bear (neither a bull)
As I hinted at previously, I am not necessarily convinced that Kohl’s plan will work. But, at the very least, the company has sketched a path forward. As complex as the roadmap might look, I think that it hits the important points: a focus on casual wear, the online channel, and “inventory minimalism”.
The mere perception that Kohl’s could succeed in its transformation might be enough to send shares higher. Case in point, the stock has already started to move. But, also, notice below that nearly 20% of the share float is currently shorted, up from about 11% this time last year. A snowball effect of optimism could cause a short squeeze, hurting bears along the way.
For these reasons, I am no longer a KSS bear. However, I do not feel comfortable being a bull either, at least until I see clear signs that Kohl’s business fundamentals have started to improve. For now, I will sit on the sidelines and watch this interesting story in the retail space continue to unfold.
Beating the market by a mile
I do not own KSS because I have been focused on creating superior risk-adjusted returns in the long run using a different strategy – which has been very successful. To dig deeper into how I have built a risk-diversified portfolio designed and back-tested to generate market-like returns with lower risk, join my Storm-Resistant Growth group. Take advantage of the 14-day free trial, read all the content written to date and get immediate access to the community.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.