Kohl's Earnings: Weaker Sales and Lower Margins

After showing some signs of improvement during the second quarter, department store operator Kohl's (KSS -3.68%) missed analyst estimates on all fronts when it reported its third-quarter earnings this morning. Comparable-store sales declined at a faster rate compared to both last quarter and the third quarter of 2013, and profit margins suffered a troubling contraction. Shares were down about 3.5% as of 11:30 a.m. Here's a deeper look at Kohl's third-quarter earnings.

Earnings rundown
After beating analyst estimates for earnings during the second quarter, Kohl's came up short during the third quarter:

Source: Kohl's and Yahoo Finance 

Analysts were already expecting an earnings decline, but Kohl's reported an even larger degradation to its bottom line. Net income fell by 20% year-over-year, with EPS declining by 14%, buoyed a bit by share buybacks. This comes just a quarter after Kohl's reported a 9% rise in EPS.

Operating expenses rose slightly even as revenue declined, leading to an operating margin of 6.9%, compared to 8.2% during the third quarter of 2013. Gross margin also slipped, falling to 37.2%, down 30 basis points year-over-year.

After showing a sequential improvement in comparable-store sales during the second quarter, Kohl's was unable to keep that momentum going in the third quarter. Total revenue fell 1.6%, and comparable-store sales declined by 1.8%.

Source: Kohl's

This is a worse result than last year, and it appears the improvements that Kohl's reported during the second quarter evaporated during the third quarter. During the company's conference call following its second-quarter earnings release, management stated that comparable-store sales had improved throughout the quarter, and that the month of July was the first time in several months that comps turned positive.

This trend didn't hold, however, and the company may have had a tougher back-to-school season than the positive readings from July seemed to foretell.

Widespread trouble for department stores
Kohl's is not the only department store struggling, and its issues during the third quarter may have more to do with the environment than anything else. J.C. Penney (JCPN.Q) reported flat comparable-store sales during its third quarter, a big disappointment given how poor sales have been over the past two years. Comps fell by 4.8% during the third quarter of 2013 and by a whopping 26.1% during the third quarter of 2012, and being unable to grow sales from such a depressed base is not a good sign.

Even Macy's (M -1.81%), which has been far more consistent than its competitors, reported a comparable-store sales decline of 0.7% during its third quarter, after managing growth in excess of 3% during the second quarter. Unlike Kohl's, however, Macy's was able to grow its earnings thanks to a reduction in operating expenses.

The widespread weakness among department stores puts Kohl's poor results in perspective, although its inability to keep costs in check, leading to a large decline in earnings, is still a disappointment. Macy's is expecting its own comparable-store sales to rise by 2%-3% during the holiday quarter, and with the National Retail Federation predicting a 4.1% increase in holiday retail sales this year, the poor results during the third quarter may be more of a blip than the beginning of a trend.

Kohl's third quarter was disappointing, but the results from its competitors seem to point to industrywide weakness causing at least a portion of its sales decline. Its inability to keep costs in check is the biggest problem with Kohl's results, and the company will need to have a strong holiday season, in terms of both sales and profitability, to show investors that its strategy is actually working.