Kohl's: Can Strong Results Persist?
Despite good second-quarter results, we still anticipate pricing gains to be difficult for the no-moat retailer during the next decade, pressuring gross margins.
Marking its fourth consecutive quarter of positive same-store sales growth (up 3.1%) implies that initiatives surrounding localization, speed, and choice are resonating with consumers at Kohl's (KSS). However, we contend that nearly all retailers are taking such customer driven pivots and that these efforts should allow Kohl’s to defend, rather than grow its market share (with flat sales growth over the last three years versus the department store industry which averaged more than 3% declines). Kohl’s still operates in a fragmented industry with increasing price competition and slowing traffic declines, factors that underlie our no-moat rating. We don’t believe either the brand or cost structure are differentiated enough to create an economic moat, evidenced by fairly flat traffic commentary from the company over the last few quarters.
We don’t plan to materially alter our $59 fair value estimate, despite a strong second quarter at Kohl’s, which clocked 4% sales and 11% operating margin growth. Even with Kohl’s updated outlook for the year, which includes same-store sales of 0.5%-2% (from 0%-2% prior, versus our estimate of 1%) and earnings per share of $5.15-$5.35 (from $5.05-$5.50 and our $5.13 estimate), we don’t think this warrants a meaningful shift for either our second-half or long-term outlook. Over the next decade, we still anticipate pricing gains to be difficult given the categories the firm operates within, pressuring gross margin gains, and we believe Kohl’s will continue to spend on IT and store-based initiatives to defend its business, driving up SG&A expenses. Ultimately, this leads to operating margins that compress to just above 5%, around a 200 basis point drop from 2017, as we don’t anticipate secular headwinds will abate over our time frame.
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Jaime M. Katz, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.