2023-06-22 23:04:29 ET
Summary
- In Q1 2023, Kohl's top line continued to decline with a downward trajectory expected in the near term.
- A transformation strategy is underway, but much depends on execution.
- Kohl's is up against strong competitors with solid competitive advantages giving them an upper hand in terms of market share gains long term. KSS's turnaround may be an uphill battle.
American department store giant Kohl's ( KSS ) look enticing with a 9% dividend yield however risks are significant due to challenging prospects and execution risks.
Q1 2023: net sales continue downward trend, but margins improve
Kohl's reported net sales down 3.3% YoY to USD3.4 billion while comparable sales dropped 4.3% YoY. Gross margin expanded 67 basis points while operating margin rose 55 basis points to 2.8%. Inventory dropped 6%.
Near term prospects are expected to remain soft due to macro challenges. Although sharpened inventory and cost control could support cash flows, inflation (although moderating still remains elevated), and elevated interest rates are cutting into consumer purchasing power, particularly for middle income customers that make up Kohl's target market. For FY 2023, net sales are expected to drop 2%-4% and operating margin is expected at 4% improving from 1.4% last year.
Medium term prospects look challenging as well. America's department stores have long been in secular decline driven by the country's shrinking middle class , consumers switching from shopping offline to shopping online, and increasing competition from big-box retailers like Walmart and Target, and online retailers like Amazon. Kohl's transformation strategy has merits but much depends on execution. In addition, stiff competition and limited competitive advantages suggest challenging prospects.
Partnership with Sephora looks good on paper but remains to be seen if it could successfully help drive sales at Kohl's
In December 2020, Kohl's inked a partnership with Sephora to open Sephora mini-stores within Kohl's stores. The partnership aimed to have 850 Sephora stores in Kohl's stores by this year (which would cover nearly three quarters of Kohl's 1,170 store locations). In theory, the strategy has merits as it could help Kohl's drive traffic to their stores, capitalize on the thriving , recession-resilient prestige beauty sector, as well as help them shift away from their core middle class customer base and target a more affluent customer base. Kohl's is aiming to turn Sephora at Kohl's into a USD2 billion business.
However, whether this could revive sagging sales at Kohl's remains to be seen but results so far are not particularly encouraging; for FY2022 (year ended January 2023), net sales were down 7.1% YoY and comparable store sales down 6.6%. In Q1 2023, net sales decreased 3.3% YoY and comparable sales dropped 4.3%, improving sequentially (Q4 2022 net sales dropped 7.2% and comparable sales dropped 6.6%). While Sephora may have helped boost store results over the last two quarters, it is also likely that foot traffic may have got a boost from post-pandemic tailwinds as shoppers return to in-store shopping. For Q4 2022, digital sales dropped 12% YoY , and the decline accelerated in Q1 2023 with digital sales dropping nearly 20% .
Looking ahead, based on currently available information about Kohl's strategy, prospects are cloudy. Sephora and Kohl's draw very different customer bases (Sephora's target market is primarily higher-income, young women while Kohl's tends to attract middle class, value-oriented families), and Kohl's may be some distance away from appealing to Sephora's customer base in terms of merchandise, customer service, digital capabilities, pricing, store interior design, and market positioning. Kohl's management is not sitting still though, with efforts to change their pricing strategy (the company is testing everyday value pricing), revise store layouts , and adjust merchandise (shifting towards gifting and home goods) underway, but much depends on execution. An article on The Street highlighted execution gaps such as a gulf between the Sephora store experience and the Kohl's experience (which made Kohl's seem more "a landlord to Sephora"), and the fact that the Sephora stores were located too close to the entrance which means shoppers shopping at Sephora may not have stepped into the rest of Kohl's at all.
Kohl's evolution is likely to take considerable time (in terms of product sourcing, building supplier relationships etc), and investors may have little patience, presenting a headwind to the stock's price long term.
Stiff competition in all product categories notably from Amazon, but limited competitive advantages
Competition is stiff across all of Kohl's major product categories, notably from Amazon ( AMZN ) who competes across a varied price range, Walmart ( WMT ) who is squeezing market share at the value segment and Target ( TGT ) competing slightly above Walmart on the price tier. All three have significant competitive advantages and market positioning. Amazon has the advantage of unrivaled variety (including a wide selection of national brands), technological and logistics superiority, excellent customer service, competitive prices, and a highly attractive subscription program that has captured more than 80% of America's internet users. Walmart and Target have the advantage of a grocery business which draws regular foot traffic benefiting their respective apparel and homeware sales.
Arguably their biggest competitive advantage however is access to unrivaled quantities of consumer purchase data generated from sales of their own products as well as from third party sellers on their sprawling marketplace platforms which Kohl's got into the race only this year after a successful pilot. Access to such data enables the trio to discover and respond to market opportunities faster and with better accuracy, notably through their respective collections of higher-margin private label products. About a third of Kohl's sales are generated from private label brands and a data disadvantage could mean a less competitive private label portfolio.
Kohl's 10-K, FY2022
While it could be argued that Kohl's has the advantage of a wide physical store network that is within 10 miles of 80% of the U.S. population, an advantage Amazon doesn't have, that advantage could soon be under threat with Amazon opening their first physical fashion retail store last year - Amazon Style. With fresh interiors, omnichannel retailing technology that allows customers shopping online through the app to try selections at the store, and machine learning technology that helps customers find products and personalize recommendations, Amazon Style offers a shopping experience Kohl's may find challenging to match. Amazon's encroachment into the physical department store space could result in further market share erosion for Kohl's down the road.
Conclusion
Analysts are mostly neutral on the stock.
WSJ
Kohl's stock is down 43% YTD and currently offers a 9% dividend yield which looks enticing. Management is focused on strengthening the balance sheet and bottom line, which could be potentially positive on near term share performance.
Longer term, their turnaround efforts are underway and on paper the initiatives have some merit; their partnership with Sephora could increase foot traffic and draw an affluent crowd, their store renovation efforts could give shoppers an incentive to make the trip to the store, and their focus on eCommerce could support sales growth while providing insights on shopper purchase behavior. Execution risks however remain and their limited competitive advantage against bigger and stronger rivals with significant competitive advantages of their own, notably Amazon, suggest challenging prospects for Kohl's and therefore at this point it is difficult to see the company generating above average returns on capital for the foreseeable future. A high soft interest of 21% reflects pessimism over the company's prospects.
Investors willing to tolerate the risks may view it as a hold.
For further details see:
Kohl's 9% Dividend Yield Looks Enticing But Considerable Risks Present