Department stores have reported surprisingly strong second-quarter results this month. Pent-up demand has enabled many companies in the perennially challenged sector to surpass their 2019 sales volumes in recent months. Moreover, department stores are capitalizing on tight inventory across the retail industry to cut back on discounting, boosting gross margin.
On Thursday, Kohl's (KSS -6.44%) became the latest department store chain to reveal a big earnings beat for the second quarter. Let's take a look.
Completing the sales recovery
At the beginning of the COVID-19 pandemic last year, Kohl's top line plunged by more than 40%, as it was forced to shutter its stores temporarily. The company's sales trajectory steadily improved over the course of 2020, though. By the fourth quarter, sales were down a comparatively modest 10.1% year over year. Kohl's made further progress in the first quarter of fiscal 2021, reporting total revenue of $3.89 billion -- down just 4.9% compared to Q1 2019.
Last quarter, Kohl's completed its journey back to pre-pandemic sales levels. Total revenue reached $4.45 billion on net sales of $4.22 billion, up more than 30% year over year. In the second quarter of fiscal 2019, the department store giant posted revenue of $4.43 billion on net sales of $4.17 billion.
Generating slightly more revenue compared to two years ago represented an important step in Kohl's recovery. That said, U.S. retail sales have exceeded 2019 levels by nearly 20% over the past few months. Sure enough, many of Kohl's rivals posted stronger sales results last quarter.
Profitability and cash flow surge
While Kohl's top-line results were nothing to write home about, you couldn't say the same thing about its earnings. Gross margin surged to 42.5% from 33.1% a year ago and 38.8% in the second quarter of fiscal 2019, as Kohl's cut back on promotions in light of industry conditions. Meanwhile, the retailer held operating expenses below 2019 levels.
This drove explosive earnings growth. Kohl's operating margin reached a 10-year high of 12.8% last quarter. Earnings per share (EPS) surged to a second-quarter record of $2.48, more than twice the analyst consensus of $1.16. For comparison, Kohl's recorded second-quarter EPS of $1.51 in fiscal 2019. And at the beginning of fiscal 2021, management projected that the company's EPS for the entire year would land between $2.45 and $2.95.
The strong bottom-line performance helped Kohl's generate an incredible $1.25 billion of free cash flow last quarter. That in turn enabled it to repurchase $255 million of stock while still ending the period with more cash than debt on its balance sheet.
In light of its huge Q2 earnings beat, management raised its full-year guidance for the second time this year. Kohl's now expects to generate record adjusted EPS between $5.80 and $6.10, compared to its prior forecast range of $3.80 and $4.20.
Don't worry about lagging sales
Based on the company's latest guidance, Kohl's stock trades for less than 10 times earnings. That's a bargain price if the company can grow its earnings over time, especially given its strong balance sheet.
The only red flag in Kohl's second-quarter earnings report was that revenue growth relative to 2019 substantially trailed the broader retail industry. However, inventory shortages probably contributed significantly to this underperformance. While most retailers have faced supply chain challenges this year due to pandemic-related factory closures and port congestion, Kohl's appears to have fared particularly poorly. It ended the second quarter with inventory down 25% from two years ago.
Additionally, Kohl's just began the rollout of its extremely promising partnership with beauty retailer Sephora. This initiative should drive a substantial amount of incremental revenue growth as the rollout continues over the next few years. The company also continues to add other powerful brands to its merchandise mix, such as Tommy Hilfiger and Eddie Bauer.
As a result, Kohl's is poised to continue driving sales and earnings to new heights in the years ahead. That makes Kohl's stock an enticing bargain for long-term investors.