Kohl's Keeps It Simple

By Stephen D. Simpson, CFA | November 10, 2010 AAA

The retailing industry constantly recycles itself, as once-popular stores lose touch with their shoppers and fade away and newer entrants more in tune with customers rise to the fore. Kohl's (NYSE:KSS) is hardly a newcomer, but the company is showing that it has the mettle to last in the cutthroat world of broad-line apparel retailing.

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A So-So Quarter
Kohl's may be winning the war, but the company does not win every battle. For the third quarter, the company delivered total sales growth of a bit more than 4% on the back of 1.8% comp-store sales growth. That 1.8% is below the company's 2 to 4% target, but perhaps not so much so to be a long-term worry. Interestingly, it appears that traffic stayed pretty strong, but the average ticket declined - a positive outcome in the sense that it means shoppers keep showing up at Kohl's, even if they are spending less.

Profitability was a bit more of a concern. Gross margin did rise 50 basis points, but the company lost all of that and more on the SG&A line, leading to a 50-basis point decline in operating margin. Kohl's also reported a 5.9% increase in inventory; a figure that bears monitoring for the next quarter or two.

The Road Ahead
Kohl's is maintaining its 2 to 4% comp growth expectations going into the fourth quarter, but investors will likely want to see some better near-term news on the sales front. October was not a great month for Kohl's, with sales down about 2.5%, while rivals like JC Penny (NYSE:JCP) (down 1.9%), Macy's (NYSE:M) (up 2.5%) and Gap (NYSE:GPS) (up 2%) were all stronger. Of course, one month means relatively little, but bad news inevitably starts with a bad month.

Pulling away from the micro-focus of month-to-month same-store sales, there is a lot to like about Kohl's. Private-label and exclusive brands have moved towards 50% of total sales, and that is a differentiating edge for the company. While other companies like Target (NYSE:TGT) are rolling out more of their own brands as well, these tend to be "sticky" and keep customers returning to a store. Moreover, Kohl's is definitely benefiting from its away-from-the-mall store locating policy, though JC Penny is among those trying to replicate this strategy.

The Bottom Line
It is curious to see that Kohl's trades at basically the same trailing EV/EBITDA ratio as the likes of Macy's, JC Penny and Sears Holdings (Nasdaq:SHLD), even though Kohl's has been a better operator in terms of metrics like ROIC (the sales growth comparisons are more muddied). Maybe this is a "what have you done for me lately?" phenomenon where investors believe that these rivals have closed the gap and will outperform Kohl's for the next few years.

Patterns seldom change that quickly, though, and Kohl's seems to be separating itself from the pack, not falling back to it. Investors who agree might find these shares trading at a reasonably appealing price, though more value-conscious investors may need to wait for a sale. (For more, check out Analyzing Retail Stocks.)

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