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Summary
Readers may find my previous coverage via this link. My previous rating was a buy as I believed Kohl’s Corporation (NYSE:KSS) would see a recovery in FY25, where its growth recovers back to the historical rate and margins revert to the historical rate. I am reiterating my buy rating as I remain positive on KSS’s near-term outlook, where I believe management can continue its track record of beating EPS guidance and meet consensus FY25 EPS estimates of $2.67. While the market seems to be negative based on the recent results, I am positive about it given the expected core business performance and additional opportunities in adjacent categories.
Financials and Valuation
KSS reported a 4Q23 sales decline of 1.1% to $5.71 billion, driven by a same-store-sales [SSS] decline of 4.3%, where two out of three months in the quarter were negative and one month was flattish. However, gross profit outperformed estimates, coming in at $1.85 billion, which drove the beat across other profile lines (EBIT came in at $299 million vs. expectations for $273.4 million), and net income came in at $186 million vs. expectations for $142.5 billion (the lower tax rate was a big contribution to the beat). This ultimately drove an EPS beat of $1.67 vs. the consensus expectation of $1.27. Balance sheet-wise, KSS quarter-end inventory declined 9.7% and ended the quarter with $183 million in cash. On a full-year basis, FY23 did better than my previous assumption, where growth was in line with what and EBITDA margin came in 90bps higher than I expected.
KSS guidance now calls for $2.40 in FY24 EPS, which implies FY24 net income of $266 million based on the current shares outstanding of 110.91 million, and this translates to 1.5% of net margin (using consensus estimates). Given the investments required for management FY24 strategies (high upfront cost layout), I think the guide is reasonable. However, I would note that management has been beating the midpoint of its EPS guidance every single time by an average of ~3%, with the recent FY23 beat of 14%. Suppose the 3% beat trend continues into FY24; this implies an EPS of $2.472. As we move into FY25, KSS should start to reap the benefits of these investments, setting up further top-line growth and net margin expansion (note that historical net margin is in the in the mid-single digits). Hence, I believe consensus FY25 EPS estimate of $2.67, which implies ~8% growth from $2.47, is definitely possible. Attaching KSS historical forward PE multiple of 9.7x to $2.67 suggests a share price of $25.90, which is a 10% upside from the current share price. The other leg of the total return upside is the dividends that KSS is expected to issue. The current dividend expectation (using market estimates) is $1.84 per share, and that is an attractive yield of 7.7%. Collectively, my total 1-year return is ~18%.
Comments
Contrary to the apparent negative view that the market has (as seen from the share price dip in recent weeks), I continue to stay positive about KSS’s outlook, and fundamentals seem to suggest KSS is moving in the direction I expect it to. First of all, KSS’s core business (apparel and footwear), which represents 75% of the sales mix, should see improvements in 2024 after enhancing processes to deliver more relevant products. There are multiple drivers at play here. KSS is going to grow the number of women-dedicated in-store dress shops to 700 stores in 2024, which should enable it to continue the momentum that KSS saw in FY23, which saw positive SSS growth. For men’s, the expansion in product range should attract more traffic and customers as it serves more wearing occasions. On this point, I believe it also shows KSS’s ability to identify trends in one of their target verticals (they first talked about this polish casual trend in 1Q24) and implement a strategy to take advantage of this in other verticals (men’s in this case). FY24 is also going to see benefits from the ramp-up in juniors, which was only introduced in late FY23, which has seen very strong traction so far, evident from the 500bps sequential improvement in 4Q23 sales.
Aside from the core business, the announcement of a >$2 billion sales opportunity across adjacent categories such as home, baby gear, gifting, and impulse definitely adds a bullish point to my view of the business. In the home category, KSS is going to expand aggressively into home décor, which I think is a timely decision because mortgage rates are going to decline when the Fed cuts rates in the coming months. A lower mortgage rate should reignite existing home transactions (in addition to the hot new housing demand environment), thus driving more demand for home products. Encouragingly, KSS has seen a strong initial customer response to the in-store home décor assortment so far. In the Baby Gear category, KSS announced a new partnership with BabiesR Us and sees opportunity to drive new and younger customers into stores. In the fall of 2024, the company plans to open approximately 200 BabiesR Us stores in certain Kohl’s locations, with the first openings scheduled to start in August of that year. The new stores, which will be anywhere from 750 to 2,500 square feet in size, will be a great addition to KSS’s current baby selection and will allow customers to shop for all of their baby needs in one convenient location. This enlarged selection will also be accessible on Kohls.com and linked to KSS’s existing loyalty programs, such as Kohl’s Cash – which increase the engagement frequency of customers. In the gifting category, the strategy of broadening assortments and building awareness has played out well, where FY23 saw strong performance across all key events, with 50% of the holiday gifting assortment new in 2023. If KSS repeats this same strategy, I would expect FY24 to see similar traction as FY23. Lastly, for Impulse, management’s strategy in the store layout (i.e., queuing fixtures) has worked pleasantly, as they saw 40% growth in impulse sales in FY23.
Collectively, we see these underpenetrated categories has more than $2 billion sales opportunity over the next several years. Source: 4Q23 earnings call
Risk
The investments that KSS is going to implement in FY24 require a lot of capital layout upfront, so if demand does not materialize (say, a recession happens instead of Fed cutting rates), it would be a double whammy to KSS financials as growth slows and profit margins get hit by higher fixed costs.
Conclusion
I am recommending a buy rating for KSS. Despite a recent share price dip, I believe KSS core business appears healthy and poised for improvement in 2024. Management’s track record of exceeding EPS guidance and the potential for growth in adjacent categories like home décor and baby gear gives me confidence that it can meet consensus FY25 EPS estimates. While upfront costs for these initiatives pose some risk, I think the potential upside outweighs the downside.