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Published: August 17, 2010
One of the benefits of closely monitoring stocks month after
month is that you get to identify great companies to put on your
watch list. And when these companies temporarily fall out of
favor, you can take advantage. During the past decade, I have
always been very impressed with the consistent sales execution
and profit growth from Kohl's (NYSE: KSS). The retailer
has clearly replaced Macy's (NYSE: M) as the most
effective department store operator, and always seems poised for
steady further growth. Yet shares have never quite seemed like a
bargain. Until now.
Kohl's shares have fallen for five straight sessions (through
Monday) and, even though they have bounced about +2.5% in
Tuesday trading, the shares are still near 52-week lows, thanks
to recent conservative management guidance. They caution that
sales and profits may be constrained in the next few quarters as
consumers hit the pause button and one-time issues hit the
income statement. But looking into 2011 and 2012, Kohl's winning
formula of appealing merchandise and very judicious use of
working capital should enable the retailer to once again boast
the best metrics in the business.
Cautious or realistic?
When Kohl's reported fiscal second quarter results last
Thursday evening, the retailer delivered its typical set of
solid financial barometers. Same stores sales rose +4.6% in the
quarter (which is no easy feat in the face of a depressed
consumer), gross margins continued their steady upward march,
and per-share profits came in slightly ahead of forecasts.
Yet management cautioned that same store sales in the current
quarter may only rise in the +2% to +4% range, slightly below
analysts' forecasts. That partially led to a profit forecast
that was also below estimates. The main culprit for expected
near-term profit weakness: uncertainty over newly-established
credit card rules that has led management to freeze new credit
card openings until they can ascertain the new rules' impact
along with financial advisor JP Morgan (NYSE: JPM).
Kohl's expects this issue to only last for a quarter or two.
But it's important to know that any near-term sales and profit
weakness is not a function of toughening competition or a
misguided merchandising strategy. Instead, it is simply a
function of weak consumer spending. On a full-year basis,
profits are only expected to rise +10% to 12%, which again, has
to be applauded at a time when consumers are loathe to spend.
A stealth private label play
As the
economy rebounds, investors are likely to notice a subtle
shift taking place at Kohl's. The retailer has been steadily
expanding its private label offerings, and consumers seem to
have really warmed up to the company's internal brands. Sales of
these private label clothes and shoes rose +20% in the most
recent quarter and now account for a company-record 49% of
sales.
As is the case with supermarkets, clothing retailers love
private label merchandise, thanks to superior profit margins.
It's why analysts think sales will not only rise +5% in fiscal
(January) 2012, but per share profits should rise by about +15%
to around $4.20. Analysts at Smith Barney think the combination
of rebounding consumer spending along with steady margin gains
should take
earnings per share (EPS) to nearly $5 by fiscal
2013.
This is why shares of Kohl's have suddenly become so compelling.
They trade for less than nine times that 2013 profit view. It's
the first time in the retailer's history that it has sported a
single-digit forward multiple.
Most importantly, the consumer will eventually spring back to
life. Footwear and apparel tend to wear out and need to be
replaced. And Kohl's has already won the hearts of minds of many
consumers by stealing their allegiance away from retailers like
Macy's, JC Penney (NYSE: JCP) and Nordstrom's (NYSE:
JWN).
Kohl's management insists there is still ample room to expand
the company's base of stores. Expect a combination of modest
same store sales increases and annual +3% to +4% expansions in
the number of stores to yield sales growth in the +7% to +9%
range. And with ongoing gross margin gains and better leverage
on fixed costs, profits can grow at twice that rate. Of course
once those trends are in evidence again, shares will no longer
be this cheap.
Action to Take --> The best
time to buy solid companies is when they have moved out of the
spotlight. The consumer may remain weak into 2011, so Kohl's
shares may not rebound quickly. But investors can feel very
comfortable owning shares at these levels.
-- David Sterman
Staff Writer
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