Department store company Kohl's (KSS 1.49%) has been struggling with declining sales for more than a year now, and its third-quarter results offered more of the same. Comparable-store sales declined, profits declined, and it became clear that Kohl's turnaround efforts are in the early innings. But despite the poor performance of the company as of late, there are a few reasons to believe that the stock, which hasn't done much over the past five years, could rise in the long term.
Returning to store traffic growth
Many retailers have been struggling to reverse the trend of declining foot traffic, and Kohl's is no different. With online shopping growing its share of total retail sales, physical stores can no longer live by the mantra, "If you build it, they will come."
Kohl's is banking on two initiatives to drive customers back to its stores. First, the company recently rolled out a new loyalty program nationwide. The program is set up to encourage repeat visits, since the rewards must be used within 30 days, and during the testing phase, Kohl's found that loyalty members made two extra annual trips to its stores.
The second initiative is an expanded beauty department, which Kohl's is rapidly rolling out. This is similar to what competitor J.C. Penney (JCPN.Q) has done with its Sephora boutiques, which drive $600 of sales per square foot per year, more than triple the average performance of J.C. Penney stores as a whole. Kohl's is hoping that the beauty department will not only provide a boost in sales, but also drive repeat visits, and so far the results in the limited number of stores with new beauty departments have been encouraging.
Kohl's needs to stop the store traffic decline in order to return to revenue and earnings growth, and the loyalty program and the new beauty departments have the potential to do just that. If the nationwide rollout of these initiatives prove successful, earnings and the stock price could be set to rise.
Bringing back national brands
One factor that led to declining store traffic was an overreliance on private-label brands. In 2012, about 54% of Kohl's sales came from private-label brands, up from 30% in 2007. On the one hand, this increase led to a rising gross margin, since private-label merchandise tends to be more profitable. The downside, however, is that the lack of well-known national brands began to drive customers into the arms of competitors.
Kohl's has now started to increase its focus on national brands. During the most recent quarter, national brand penetration rose by 230 basis points, and while total comparable-store sales declined, national brand comps were positive for the second quarter in a row, outperforming private-label merchandise.
Kohl's will be continuing to roll out additional national brands over the next couple of years, correcting the mistake that drove customers away. This will lead to lower gross margins, but selling the brands that customers actually want is a critical step in returning to store traffic growth. Earnings aren't going to rise in the long term if Kohl's continues to bleed customers, and the performance of the stock depends on Kohl's getting its product mix right.
Growing online sales
While Kohl's is working to get customers back to its stores, it's also attempting to grow its online business. During 2013, Kohl's online sales represented about 7.3% of total sales, and while its online sales are growing quickly, Kohl's will need to keep up this growth in order to avoid being left behind as e-commerce sales increasingly supersede brick-and-mortar sales.
Kohl's is taking a few steps that should help boost its online sales performance. First, the company now has the capability to ship online orders directly from about 800 of its stores. Kohl's has four online distribution centers in the United States, but for customers that don't live close to them, shipping times can be slow. Ship-from-store allows for Kohl's to increase its shipping speed utilizing its existing stores, a far less costly option compared to building new distribution centers.
Kohl's is also testing a buy online, pick-up-in-store program in 100 of its stores. Many retailers already offer this option, and it allows customers the convenience of shopping online along with the ability to get their items almost immediately. Kohl's will need good execution for this to be a success; having customers wait too long at the store to pick up their orders could ultimately drive them away.
If Kohl's can keep growing online sales in the double-digit percentages, it could make up for in-store weakness and allow the company to grow sales without a vast improvement in store traffic. Margins will likely be lower online, especially in the short term, but returning to growth and growing its market share is a critical first step in Kohl's turnaround effort. If Kohl's can keep the online momentum going, sales growth and a rising stock price could be in the cards.
