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Earnings Preview: Is Kohl's Getting Back on Track?

By Adam Levine-Weinberg – Aug 19, 2019 at 9:35AM

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The No. 2 U.S. department store chain got off to a weak start in 2019, but the first of several key sales growth initiatives began to kick in last month.

After a multiyear run of mediocre performance, Kohl's (KSS 3.07%) finally seemed to get its house in order about two years ago. Unfortunately, the No. 2 department store operator's results took a sudden turn for the worse in the first quarter of fiscal 2019.

Back in May, Kohl's executives warned investors not to expect an immediate rebound in sales and earnings for Q2. However, they did predict that performance would improve significantly in the second half of the year, starting with the back-to-school season. Kohl's upcoming second-quarter earnings report and conference call will give investors more insight into whether business trends are turning around as expected.

Kohl's growth streak ends

In the second half of 2017, Kohl's began a streak of six consecutive quarters of comparable-store sales growth. For fiscal 2017 as a whole, Kohl's posted a 1.5% comp sales increase, largely due to a stellar 6.3% comp sales gain in the fourth quarter of that year. Growth continued throughout fiscal 2018, with comp sales rising 1.7% on a full-year basis.

This return to sales growth -- along with improved inventory management and the reduction of the federal corporate tax rate in late 2017 -- enabled Kohl's to achieve strong earnings growth. Adjusted earnings per share soared from $3.76 in fiscal 2016 to $5.60 in fiscal 2018.

Entering fiscal 2019, management expected adjusted EPS to rise to between $5.80 and $6.15, driven by another year of modest sales growth. However, sales slowed dramatically in the first quarter, as comp sales fell 3.4% year over year. Sales trends were particularly poor in February, but March and April fell short of management's initial expectations, too.

The exterior of a Kohl's store

Kohl's sales trends deteriorated sharply in the first few months of 2019. Image source: Kohl's.

Careful expense management limited the impact to Kohl's profitability in the first quarter. Adjusted EPS declined just 5% year over year, to $0.61. Nevertheless, Kohl's slashed its full-year EPS guidance by more than 10%, to a new range of $5.15 to $5.45.

Little improvement expected in the second quarter

During Kohl's Q1 earnings call, CFO Bruce Besanko said that sales trends had remained weak in May. As a result, management told investors to expect comp sales to continue falling in the second quarter, albeit at a more moderate pace. CEO Michelle Gass also said that the company was being more aggressive on pricing and promotions to drive traffic, which likely led to more severe margin erosion for Kohl's last quarter.

On the flip side, Kohl's began accepting returns for Amazon.com (AMZN 3.15%) in all of its stores in early July, just in time for Prime Day. While the Amazon returns partnership will create some additional expenses, Kohl's tested the program extensively beginning last year and found that the benefits from increased customer traffic outweighed the incremental costs.

Investors will be eager to hear how the nationwide rollout of Amazon returns impacted Kohl's second-quarter results. Some of the early third-party data is promising, showing a substantial increase in traffic after a Kohl's store begins accepting returns for Amazon purchases.

Kohl's also may have benefited last month from the launch of a new brand partnership with Nine West. Kohl's now sells apparel, shoes, outerwear, and handbags from Nine West, which could attract new customers to the department store chain.

More traffic drivers on the way

In the long run, Kohl's success will depend on its ability to drive more traffic to its stores and website without relying on deep discounting. That's why Gass has made the Amazon returns program her signature initiative. It ensures a steady flow of traffic to Kohl's stores. If the retailer has compelling merchandise available, this should naturally boost sales.

That's also why Kohl's is leasing excess space in certain stores to high-traffic tenants like Aldi and Planet Fitness. Even if only a fraction of those chains' customers stop in at Kohl's as well, it could provide a meaningful traffic boost. (The rental income will help the bottom line, too.)

Meanwhile, Nine West is just the first of several new brands that Kohl's is bringing into its stores in the second half of 2019. These new brands could help Kohl's boost customer traffic and sales -- even with less discounting.

Kohl's isn't likely to report impressive results for the second quarter. But Kohl's stock could start rising again if management provides compelling evidence that the company's sales-driving initiatives are already gaining traction.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levine-Weinberg owns shares of Kohl's. The Motley Fool owns shares of and recommends Amazon and Planet Fitness. The Motley Fool has a disclosure policy.

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