In recent years, growing its beauty business has been one of Kohl's (NYSE:KSS) biggest strategic priorities. Despite some modest initial success, it was facing an uphill battle to gain share from retailers with more established beauty businesses.
Kohl's has solved this problem through a new partnership with Sephora, the global beauty retail giant owned by LVMH Moet Hennessy Louis Vuitton. Here's why the new partnership -- announced on Tuesday and scheduled to launch next fall -- looks like a game changer for Kohl's.
A category where Kohl's needed help
Kohl's stand-alone efforts to grow its beauty business have been commendable. The company piloted an enhanced beauty department in 12 of its stores beginning last year, featuring twice as much square footage, upgraded fixtures, better lighting, and wider aisles. Trained beauty advisors staffed the enhanced departments . Kohl's has also been adding new national and private brands to its beauty assortment.
Over the past five years, Kohl's beauty sales have increased nearly 40%, indicating that the company's growth initiatives have started to pay off. On the other hand, beauty still accounts for a very small portion of the No. 2 U.S. department store chain's total sales. Historically, Kohl's hasn't been a big beauty retailer. Changing consumer perceptions has been challenging. Considering that Kohl's faces strong competition from the likes of Ulta Beauty, good wasn't necessarily good enough.
A match made in heaven
Sephora is an excellent strategic partner for Kohl's. First, it is one of the best-known beauty retailers in the U.S., so it gives Kohl's credibility with consumers. Second, Sephora has relationships with a broad range of brands in makeup, skincare, fragrance, and hair care. The partnership will thus give Kohl's access to key brands. Third, Sephora has a big customer base, with 25 million members of its Beauty Insider rewards program, including lots of younger consumers.
The partnership will also have substantial benefits for Sephora. Kohl's has 1,163 stores placed so that they're within 15 miles of 80% of the U.S. population. Importantly, 95% of the store base is in convenient off-mall locations. Kohl's also has 65 million active customers. Working with Kohl's will allow Sephora to tap into a huge customer base that it can't serve well from its roughly 500 U.S. stores, most of which are located in malls or major cities.
Kohl's is also a far more desirable partner than J.C. Penney, Sephora's main partner in the U.S. since 2006. It is nearly twice J.C. Penney's size and has a much better reputation. Moreover, J.C. Penney stores are mostly located in malls, an arrangement that isn't very helpful for Sephora. In high-performing malls, Sephora typically has its own stores. Mid-tier malls are rapidly falling out of favor with shoppers. Earlier this year, Sephora tried to terminate its relationship with J.C. Penney. While the two sides eventually agreed to a confidential settlement, it seems likely that Sephora will exit that partnership within a few years.
How the Kohl's-Sephora partnership will work
Kohl's plans to roll out 2,500-square-foot Sephora shops inside 200 of its stores by next fall. The stores will feature prominent exterior signage to highlight the new Sephora shops, which will be positioned at the front of each store.
Furthermore, Kohls.com will exclusively offer Sephora beauty products beginning next fall. Kohl's e-commerce business will also be integrated with Sephora.com in the beauty category. By 2023, at least 850 Kohl's stores will feature the new Sephora shops.
The two companies will share equally in the profit from their new partnership. Kohl's will be responsible for the capital outlays to build Sephora shops in its stores and will own and manage the inventory. Meanwhile, Sephora will train the sales staff (who will be employed by Kohl's), curate the assortment, and oversee the vendor relationships.
Kohl's stock could keep rallying
After a steep plunge in March, Kohl's stock regained ground in the spring before stalling out for several months. The stock surged again in November thanks to a big third-quarter earnings beat and growing optimism that vaccines will tame the pandemic in 2021. It added to those gains on Tuesday following the Sephora partnership announcement.
Sephora shops have been one of the few attractions driving traffic to J.C. Penney in recent years. They will probably be even more successful at Kohl's, helping the department store chain become a major destination for beauty products and contributing to its efforts to gain market share.
If Kohl's can achieve its operating margin target of 7% to 8% -- which seems doable -- annual net income could reach $1 billion within a few years. With Kohl's market cap still sitting below $6 billion, there's plenty more upside for Kohl's stock if the new Sephora partnership helps the retailer meet its turnaround goals.