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Kohl's Did What Few Other Retailers Could Last Quarter

By James Brumley – Nov 22, 2021 at 8:20AM

Key Points

  • The company's gross margin rates are stronger than they've been in years, in contrast to other retailers.
  • Kohl's enjoys much more precise management of its inventory than other department store chains.
  • Given the difficulty of establishing new in-house brands, it's unlikely a competitor will be able to mimic its strategy anytime soon.

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The strip mall department store chain is fending off inflation's effects better than most for one big reason.

Investors who keep close tabs on retail stocks likely know Kohl's (KSS -1.56%) posted whiz-bang fiscal third-quarter results on Nov. 18. Sales of $4.6 billion topped estimates of a little less than $4.3 billion, while per-share earnings of $1.65 trounced expectations for only $0.64. The company also upped its full-year guidance, fanning the bullish flames that initially sent its stock more than 10% higher.

Lost in all the noise of this earnings news, however, is an important metric for investors looking at Kohl's through a long-term lens. That is, Kohl's gross profit margin remained remarkably high in an inflationary environment that crimped rival retailers' overall profitability.

There's a reason.

Salesperson helping someone try on a coat.

Image source: Getty Images.

Weathering the storm

It would have been easy to assume the worst for last week's quarterly report. Mega-retailer Walmart reported just a few days earlier that cost of sales grew 4.7% year over year in its fiscal third quarter, while revenue was only up 4.1%. Target's gross margin slipped to 28.0% in its fiscal third quarter, down from 30.6% in the prior-year period.

Startled shareholders sent both stocks lower following their earnings reports, despite clear warnings that rising costs across the board are cause for concern. That inflation narrative is bolstered by last week's report from the Census Bureau, which noted consumers' costs were 4.6% higher last month than they were a year ago when excluding food and energy costs, and up 6.2% when including the price of food and gasoline.

Kohl's, however, continues to weather the storm. Its gross margin improved from 35.8% last year -- a time when other department store chains were struggling to sell their goods at any price -- to 39.9% in its latest quarter.

And if you think that improvement is merely the result of shrugging off the effect of last year's pandemic-driven shutdowns, you'd be mistaken. The retailer's gross margin for the third quarter of fiscal 2019 was lower at 36.3%. Kohl's selling and administrative costs last quarter were also in-line with pre-COVID norms, suggesting the company is successfully navigating an employment environment marked by higher wage expectations.

Chart showing Kohl's gross profit margin rate holding up since 2017 despite inflationary pressure.

Data source: Thomson Reuters. Chart by author.

Simply put, this department store chain continues to do things right, particularly as it pertains to procuring and selling inventory.

The end result? Last quarter's net operating margin reached a nine-year high of 8.4%.

Keeping it in-house means more control

If you're wondering how the department store chain has stood up to a supply chain crisis and inflationary pressure that has challenged so many other players in the business, there's a multifaceted explanation. First, there is the simple fact that Kohl's is just very, very good at buying the right goods and promoting them the right way.

More than anything, though, its consistent margins are the result of the retailer's self-sufficiency, built around a huge private-label business. The company says a little over a third of last year's top line came from in-house brands, down from 2018's 39% (possibly due to the pandemic).

Private-label goods are inventory designed and procured by a retailer. Sometimes these items are meant to fill gaps in a store chain's assortment, though they'll often be offered side-by-side with similar items from nationally recognized brands. They're a compelling alternative for retailers as profit margins are typically much higher on private-label merchandise than they usually are for name-brand goods. They also circumvent many supply limitations imposed by national brands' relationships with their own manufacturers. Croft & Borrow, Sonoma, and FLX are just some of Kohl's in-house labels.

Surprised about those brands being Kohl's own? That's at least part of the point. This off-mall retailer does so well with private-label goods, because they look a lot like offerings from national brands. In this vein, the retailer anticipates that the launch of its athleisure brand FLX last March will eventually drive sales of activewear from 20% of its total business to 30%. That's huge.

Bolstering the bullish thesis

The company's private-label program obviously isn't the only reason Kohl's is winning in an environment that isn't easy for retailers to navigate. The department store chain also deserves a great deal of credit for managing its spending, including employee-related expenses. It uses all of its resources well.

To the extent a store chain's fiscal success begins with the right merchandise being in the right place at the right time at the right price, however, Kohl's private-label program gives it a tighter control of all of those variables that its competitors just can't match.

That's another reason to own this department store retailer over other choices in the industry.

James Brumley 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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