2023-07-26 18:55:47 ET
Summary
- Kohl's Q1 results showed an improvement from the previous year, despite a decline in total revenue by $140 million, due to cost reductions in goods sold and administrative expenses.
- The company has increased its cash position to $286 million and its inventories by nearly $350 million, but this was achieved by increasing borrowings under their credit facility by nearly $700 million.
- Kohl's has managed to decrease its unsecured debt, but the borrowing costs on some of its bonds are rising due to credit downgrades, which is eroding cash flow generation.
Kohl's ( KSS ) has faced a variety of challenges in the retail space. As a former bondholder, I sold my position at the beginning of this year due to a combination of cash flow concerns and reliance on new debt issuance. After better than expected first quarter earnings , an upgrade in the company's stock , and a price drop in the company's bonds creating yields greater than 11%, I decided to revisit my thesis for possible investment.
FINRA
Kohl's first quarter financial results showed improvement compared to the same quarter a year ago. While total revenue declined by $140 million, improvements in both the cost of goods sold and selling, general, and administrative expenses allowed operating income to finish $16 million higher than a year ago. Unfortunately, interest expenses rose which caused net income to come in at the same level as a year ago.
Kohl's balance sheet shows some capital shifted around in the first quarter. The company nearly doubled its cash position to $286 million, and increased its inventories by nearly $350 million to over $3.5 billion. The cash and inventory build did not come organically, as Kohl's increased its borrowings under their credit facility by nearly $700 million to $765 million.
A closer examination of the cash flow statement adds further concern. While Kohl's did reduce its long-term debt by $150 million in the first quarter, it came at the expense of the increasing the balance of the revolving credit facility. Essentially, Kohl's borrowed $700 million to cover a $300 million free cash flow shortfall, repay $164 million in long-term debt, pay $55 million in dividends, and hold $130 million in cash. The pace that Kohl's is burning cash makes the future of the dividend concerning.
Kohl's has managed to decrease its unsecured debt despite drawing on its credit facility. The company has another $111 million coming due this year and $460 million coming due in 2025. While Kohl's unsecured debt is manageably declining, the borrowing costs on some of its bonds are rising due to credit downgrades by S&P and Moody's in the first quarter. These coupon adjustment provisions are increasing interest expenses and further eroding cash flow generation.
Looking forward, I was particularly surprised by some comments and guidance that Kohl's made regarding the rest of the year. In the first quarter earnings call, the company stated that they would retire their 2023 maturing debt with cash on hand along with pay down their revolving credit line to zero by the year. This comes in tandem with their full year guidance, which has sales declines and capital expenditures of over $600 million.
Based on a review of last year's cash flow statement and comparing this year's guidance, I believe the only way that Kohl's can pull off paying down its revolving credit line, plus its debt maturity, plus fund its capital expenditures and its dividend would be if the company drew its inventory down by more than $1 billion. Even if it did this, Kohl's would need capital to replenish inventory next fiscal year and therefore likely need to draw on the revolving line of credit.
With Kohl's taking on more leverage through its revolving credit facility and still paying a dividend, I'm holding off on investing in its high-yielding debt. The company's newly found dependence on the credit facility undermines the recovery value of its debt (should they end up restructuring), therefore I will be looking for Kohl's to generate free cash flow prior to investing in its bonds.
CUSIP: 500255AF1.
Price: $81.65.
Coupon: 7.25%.
Yield to Maturity: 11.64%.
Maturity Date: 6/1/2029.
Credit Rating (Moody's/S&P): Ba3/BB.
For further details see:
Kohl's Debt Yields Rise, But Still Too Much Risk