Don't Be Fooled by Strong January Sales at Kohl's

On Thursday, Kohl's (NYSE: KSS  ) reported unexpectedly strong comparable-store sales growth for January. Comparable-store sales increased 13.3%, while total sales increased by 34.1% for the month due to the inclusion of an additional week in the company's fiscal year. Analysts had expected a comparable-store sales increase of just 3.1%.

However, investors should not get too excited about this accomplishment. January is one of the lightest-volume months of the year for department stores. Moreover, Kohl's achieved strong sales growth last month because of its underperformance during the holiday season. This left lots of clearance merchandise in the stores. However, clearance merchandise is sold at very low gross margin (and sometimes at a loss), which will put pressure on Kohl's profitability this quarter.

A good January is a small consolation
January tends to be the weakest sales month for retailers as consumers "recover" from the holiday season. By contrast, November and December are the strongest months of the year. As a result, it is virtually impossible to make up for a weak holiday season with strong January sales. Kohl's averaged sales of $226 million per week during the five-week January period, compared to sales of $579 million per week for the nine-week November-December period. Thus, even a large percentage increase in January sales has relatively little impact on total quarterly revenue.

In this case, Kohl's performed very poorly during the critical holiday season, with comparable sales up just 0.1% in the combined November-December period. Even after the 13.3% increase in January comparable-store sales, total fourth-quarter comparable-store sales grew by just 1.9%. This was well below the company's initial guidance (issued in the third quarter earnings release) for a comparable-store sales increase of 3% to 4% in the fourth quarter.

Some of the underperformance can be attributed to the effects of Hurricane Sandy, which hit the East Coast around the beginning of "fiscal November" (Oct. 28, 2012). However, other chains, such as Macy's (NYSE: M  ) , performed much better despite having at least as much exposure to the Northeast.

Late sales, low margins
Moreover, Kohl's needed to discount heavily in December and January in order to get merchandise moving. When the company announced December sales results in early January, Kohl's CEO Kevin Mansell commented:

December sales were lower than planned. Additionally, sales came late in the holiday shopping season and, as a result, were at deeper discounts than planned. We are taking the necessary markdowns in the fourth quarter to manage our inventory as we transition into the Spring season.

Accordingly, Kohl's reduced its fourth-quarter EPS guidance to a range of $1.60 to $1.62 at that time, compared to a prior range of $2.00 to $2.08. Given that November and December sales were so weak, it is good that the company was able to clear its inventory in January. However, the earnings benefit of higher January sales was probably minimal, because clearance merchandise is sold at such a low gross margin.

By contrast, Macy's also achieved double-digit comparable-store sales growth in January, but did so through better supply of "fresh fashion goods" that were added to the assortment after the Christmas rush. While Macy's also saw weakness in the November-December period, it still managed to post comparable-store sales growth of 2.5% in that period. Macy's somewhat better sales performance in November and December, and its lower reliance on clearance merchandise in January, allowed it to reaffirm its original fourth-quarter EPS guidance of $1.94 to $1.99.

A worrisome trend
The poor performance at Kohl's in November and December was not the company's first misstep of the year. Kohl's also made bad decisions in planning its spring and summer assortments, and ended up with insufficient inventory of items that proved to be popular. Low inventory led to a 2.7% decrease in comparable-store sales for the second quarter. Due to the disappointing second-quarter sales drop and the slow holiday season, Kohl's will post fiscal-year 2012 EPS well below its initial guidance of $4.75. Last month, the company updated its EPS guidance to a range of $4.11 to $4.13.

Missing the original earnings guidance by more than 10% would be a poor result under any circumstances. However, it is particularly disappointing because Kohl's missed a golden opportunity to take advantage of last year's turmoil at J.C. Penney (NYSE: JCP  ) . J.C. Penney's transition away from a promotional model alienated many of its former customers and resulted in a 23% sales decline in the first nine months of fiscal-year 2012. Other competitors such as Macy's and Dillard's were able to take advantage of J.C. Penney's struggles to grow their market share. Kohl's, which caters to the same middle-class customers as J.C. Penney, should have been able to do the same. With J.C. Penney planning to bring back sales this year, the competitive environment will only get tougher for Kohl's going forward.

Foolish bottom line
The brief pop in Kohl's comparable-store sales last month pales in comparison to the company's poor performance in the rest of 2012. With one of its major competitors (J.C. Penney) struggling, Kohl's ought to have gained market share and posted strong sales growth for the year. Investors should be wary of investing in Kohl's until the company can show that it has returned to consistent sales and profit growth.

Learn more about the retail industry
J.C. Penney has been a train wreck whose comeback always seems just around the next earnings corner, but people are beginning to wonder if this is the case anymore. For investors wondering whether J.C. Penney is a buy today, you're invited to claim a copy of The Motley Fool's new must-read report on the company. Learn everything you need to know about JCP's turnaround -- or lack thereof -- and as a bonus, you'll receive a full year of expert guidance and updates as key news develops. Simply click here now for instant access.


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