Department store operator Kohl's (KSS 1.49%) has been struggling for the past few quarters with declining comparable-store sales, although the most recent quarter showed some signs of improvement. Unlike rival J.C. Penney (JCPN.Q), Kohl's is extremely profitable, although margins have declined in recent years. With the stock essentially flat over the past decade and the company struggling to grow, is now the time to buy Kohl's stock in hopes of a turnaround?
Returning to growth
Kohl's has already made quite a bit of progress improving its performance. During the most recent quarter, comparable-store sales declined by 1.3%, an improvement over the 3.4% decline in the previous quarter. And according to CEO Kevin Mansell, Kohl's actually achieved positive comps during the month of July, a sign that the worst may be over.
Part of the problem for Kohl's over the past few years has been the company's shift away from national brands. Between 2007 and 2012, the percentage of Kohl's sales derived from its private label brands grew from 30% to 54%. Private label brands tend to carry higher gross margins, but the lack of national brands played a part in driving customers away. The company has now begun to reverse this process, and this should help sales recover.
Kohl's is doing plenty of other things in an effort to return to growth as well. A new loyalty program, which has performed well so far in a limited number of stores, is being rolled out nationwide. The company is investing in e-commerce, including the ability to ship online orders directly from the stores, and its online sales grew by 30% year over year in the month of July. Lastly, a new beauty department, which has been boosting sales in stores where it's been installed so far, is being further expanded, helping Kohl's capture a larger part of the beauty market.
We'll have to wait a few more quarters to see if the positive July performance continues into the back half of the year, but it appears so far that the steps Kohl's is taking are paying off.
Keeping costs in check
One thing that separates Kohl's from the competition is its ability to manage costs. Even as sales declined during the most recent quarter, Kohl's managed to keep operating income flat by reducing operating costs and only suffering a small decline in the gross margin. Historically, Kohl's has spent far less operating its stores as a percentage of revenue compared to J.C. Penney, and the near-collapse of Penney has only made this gap wider.
KSS Total Operating Expenses (% of Annual Revenues) data by YCharts
This low cost structure is one reason why Kohl's has managed to be so consistent over the years, with operating margins fluctuating around 10%. The same can't be said for J.C. Penney:
KSS Operating Margin (Annual) data by YCharts
Valuation
Kohl's earned $4.05 per share in 2013, and analysts expect this to rise to $4.30 in 2014. Share buybacks have been a big driver of per-share earnings growth, as Kohl's has spent $925 million in the past 12 months buying back its own shares, but the price of the stock is reasonable enough that share buybacks make sense. Based on the analyst estimate, Kohl's currently trades at around 14.5 times forward earnings.
Kohl's may not appear to be a bargain at that price, but if the company truly does return to comparable-store sales growth in the second half of this year, then earnings may be able to rise significantly over the coming years. During the past decade, Kohl's has averaged an operating margin of 10.4%, well above the 9.2% number achieved in 2013. If Kohl's can get back up to the average, EPS would get a boost of around $0.70 per share. Along with the continued effect of share buybacks, it's clear that earnings have the potential to grow rapidly as Kohl's recovers.
Even if the recovery takes longer than expected, 14.5 times earnings is a reasonable price to pay for a company as consistent and profitable as Kohl's, although I'd always prefer to pay less. Kohl's was trading near $51 per share just a few months ago, which would have been an even more attractive price, but a rapid rise in the stock since then has made that bargain entry point a thing of the past.
The bottom line
Kohl's is making progress in returning to growth, and it may have already succeeded. The company has done a good job at managing costs during times of weakness, and the stock trades at a very reasonable valuation. It was definitely time to buy Kohl's stock a few months ago at lower prices, but I think the stock is still a good buy today.
