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Kohl's Shrinks Its Debt Load and Prepares to Reward Shareholders

By Adam Levine-Weinberg - Updated Apr 15, 2021 at 2:53PM

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The department-store operator is finally putting its huge cash hoard to work.

During the initial wave of the COVID-19 pandemic last spring, Kohl's (KSS -19.64%) scrambled to shore up its liquidity by issuing new debt and expanding its credit facility. Yet the retailer weathered the pandemic more easily than management and investors had expected. In fact, thanks to its careful management of expenses and working capital, Kohl's generated about $1 billion of free cash flow in fiscal 2020.

As a result, the department-store chain entered this year with a ton of excess cash. Recently, it used some of that cash to pay down debt.

Nevertheless, Kohl's is still carrying more cash than it needs. On Wednesday, the company significantly increased its share-repurchase authorization, hinting that it will return cash to shareholders faster than previously expected.

Kohl's restructures its balance sheet

Late last month, Kohl's announced plans to repurchase roughly $1 billion of debt through a tender process. As of late last week, holders of $1.04 billion of debt due between 2023 and 2025 had agreed to the terms of the tender offer. Kohl's accepted all of that debt for purchase.

Due to the prevailing low-interest-rate environment, Kohl's is paying a premium for the debt it's repurchasing. That premium ranges from 5% for the lowest-rate debt covered by the tender offer to a whopping 30% for debt carrying a sky-high 9.5% coupon that Kohl's issued during the peak of the crisis last year. As a result, it spent approximately $1.24 billion to complete the tender offer.

Kohl's entered fiscal 2021 with nearly $2.3 billion of cash on its balance sheet. In short, it could have easily covered the cost of its tender offer with cash on hand. Instead, Kohl's paid for part of the tender offer by issuing $500 million of new debt. This allowed it to lock in a low 3.375% coupon for 10 years.

The exterior of a Kohl's store

Image source: Kohl's.

Reducing future interest expense

The tender offer will slash Kohl's interest expense going forward. Most notably, Kohl's was able to repurchase over 80% of the high-coupon debt it issued last year ($487 million at face value). That alone will save it $46 million annually on a pre-tax basis.

Including the other debt covered by the tender offer -- net of the interest expense associated with Kohl's recent debt issuance and a negligible amount of lost interest income -- the tender offer will cut future interest costs by about $50 million annually.

More buybacks on the way?

Even after its recent debt-reduction moves, Kohl's is on pace to end the first quarter with well over $1 billion of cash. Furthermore, it's likely to post another year of strong free cash flow in fiscal 2021, particularly because it's set to receive a tax refund totaling hundreds of millions of dollars later this year.

Kohl's quarterly dividend of $0.25 per share costs a modest $158 million per year. And the company has no debt maturities until 2023 -- and less than $800 million maturing through the end of the decade.

Thus, the department-store retailer has significantly more cash than it needs. On Wednesday, Kohl's announced that it had increased its share-repurchase authorization to $2 billion -- up from $726 million as of late January -- as part of a settlement agreement with activist investors who had been pressuring the company.

Kohl's cautioned that it isn't obligated to use that full buyback authorization. But barring any near-term setbacks for the business, it seems likely to buy back a lot more stock this year than the $200 million to $300 million it planned to spend as of early March.

Thanks to competitors' store closures, resurgent consumer demand, and Kohl's growing number of brand partnerships, the company's sales and earnings could rebound rapidly over the next two to three years. A stepped-up share-buyback program would turbocharge the resulting growth in earnings per share. While Kohl's stock has nearly tripled over the past six months, there's still plenty of upside for long-term investors.

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