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Should You Buy Kohl’s Stock for Its 3.6% Dividend Yield?

By Leo Sun – Nov 27, 2018 at 8:35PM

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Is the retailer’s stock a reliable income investment?

Shares of Kohl's (KSS) tumbled more than 20% after hitting a 52-week high earlier this month, as stock-market weakness and concerns about brick-and-mortar retailers caused investors to dump the stock. Even the company's solid third quarter report on Nov. 20, which beat expectations on the top and bottom lines, failed to calm investors.

However, Kohl's sell-off reduced its forward P/E to 12 and boosted its forward dividend yield to 3.6%. Should investors consider Kohl's to be an undervalued income play at these levels? Let's take a closer look at its latest quarter to find out.

A Kohl's store.

Image source: Kohl's.

Decelerating top line growth

Kohl's revenue rose 1.3% year over year to $4.6 billion last quarter, which was slightly ahead of expectations. Its comparable store sales grew 2.5%, clearing the consensus forecast for 1.5% growth. However, its revenue and comp sales growth have also clearly decelerated over the past few quarters.

Metric

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Revenue

9.2%

3.5%

4%

1.3%

Shifted comp sales

6.3%

0.4%

3.1%

2.5%

Year-over-year growth. Data source: Kohl's quarterly reports. Chart by author.

Furthermore, Kohl's comparable store sales growth in fiscal 2018 has been inflated by easy comparisons to its negative to flat growth in the first three quarters of 2017.

Kohl's top-line growth could continue to decelerate as it laps those gains, and its lack of comp sales guidance for the fourth quarter doesn't allay those fears. Kohl's also faces a very tough year-over-year comparison to the fourth quarter of 2017, when its revenue and comps surged 9.2% and 6.3%, respectively (the former was partly due to the extra week in fiscal 2017).

Analysts expect Kohl's revenue to grow less than 1% this year, compared to 2.2% growth in fiscal 2017, due to the extra week last year. Its rival Macy's (M) is also expected to generate less than 1% revenue growth this year, but it faces an easier comparison to its 4% drop last year.

A smaller format Kohl's store.

A smaller-format Kohl's location. Image source: Kohl's.

Improving gross margin and solid earnings growth

On the bright side, Kohl's gross margin expanded 25 basis points year over year to 37.0% last quarter, and its operating margin held steady at 5.6%. During the conference call, CEO Michelle Gass attributed this stable margin performance to strong apparel sales and the company's "focus on inventory management and speed to market" -- which boosted its sales and gross margin while keeping inventory levels under control.

Kohl's has also been focused on expanding its e-commerce ecosystem and opening smaller-format stores. This means that it isn't falling into the trap of driving sales growth with markdowns. That strength is reflected in its robust double-digit earnings growth over the past year.

 

Q1 2018

Q2 2018

Q3 2018

Net income

62%

40%

38%

EPS

65%

42%

40%

Year-over-year growth, excluding non-recurring items. Data source: Kohl's quarterly reports. Chart by author.

Kohl's expects its adjusted earnings per share to rise 24%-29% for the full year, compared to 15% growth last year. That's considerably higher than Macy's forecast for adjusted earnings growth of 9%-14% this year.

What about its dividend and valuation?

Kohl's has raised its dividend annually for seven straight years. It currently pays an annual dividend of $2.44 per share, which is easily covered by its projected EPS of $5.35-$5.55 this year, putting its payout ratio at less than 50%. This means that Kohl's has plenty of room to keep raising its dividend for the foreseeable future.

However, Kohl's forward yield of 3.6% isn't that high compared to those of other beaten-down retailers, and its forward P/E of 12 isn't that low. For example, Macy's pays a forward yield of 4.5%, but its stock trades at just 9 times forward earnings.

Kohl's forward P/E of 12 is still cheap relative to its projected earnings growth rate, which should limit the stock's downside at these levels. That said, Kohl's stock could also be weighed down by broad concerns about holiday sales, the impact of tariffs next year (especially on its apparel business), and rising interest rates -- which make bonds safer income investments.

The verdict

Kohl's is a solid income stock, but Macy's offers a higher yield at a lower valuation -- as do other stocks in less cyclical industries. Kohl's slowing sales growth could also hold back its earnings growth over the next two years. Kohl's isn't a bad investment, but I wouldn't buy it for its dividend alone.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Macy's Stock Quote
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