Just a few months ago, the stock of Kohl's (KSS -0.14%) was riding high, as a slew of bidders were offering as much as $70 per share to buy the retailer. However, following a disappointing first-quarter earnings report and guidance cut, most of Kohl's suitors lost interest.
But hopes that the company could still consummate a deal with Franchise Group (FRG) limited the damage to Kohl's stock at first. Over the past month, though, growing signs of a pullback in discretionary spending undermined the proposed deal. On July 1, Kohl's officially announced that it had ended its strategic review process and would remain public.
That caused shares to crater to below $30, down from around $60 in April. But while 2022 is shaping up to be a rough year for the department store giant, its long-term prospects remain bright. As a result, I'm taking advantage of this sharp pullback to buy more Kohl's stock.
Offers reduced and rescinded
Back in April, Franchise Group, which owns brands such as Vitamin Shoppe and Pet Supplies Plus, expressed interest in buying Kohl's for $69 per share. At the time, it was one of several bidders offering between $65 and $70 for the company.
Unfortunately, high inflation, rising interest rates, and general market turbulence made it tough for most bidders to line up financing. Making matters worse, Kohl's served up a weak first-quarter earnings report in May. The company reported that adjusted earnings per share (EPS) plummeted 90% year over year in the quarter and reduced its full-year EPS guidance by about 8%. This caused all but two bidders to drop out of the running.
On June 6, Kohl's announced that it had entered into a three-week exclusive negotiating period with Franchise Group to firm up a revised bid of $60 per share.
However, Kohl's sales trends continued to deteriorate during June. Franchise Group cut its offer again (to $53) and still didn't have firm financing in place. The Kohl's board concluded that selling the company didn't make sense in the current environment, and it ended negotiations.
More turbulence ahead
In the press release announcing the end of the strategic review, Kohl's acknowledged that demand decelerated last month. The company now expects to post a high-single-digit sales decline this quarter, compared to its previous forecast of a low-single-digit decline.
Kohl's didn't update its earnings guidance, but the sales slowdown will likely force it to roll out margin-sapping discounts to clear excess inventory, similar to rivals like Target.
Analysts have slashed their full-year EPS estimates to $4.96 on average, far below the company's most recent guidance range of $6.45 to $6.85. I wouldn't be surprised if management has to cut its full-year EPS guidance to well below $5 due to the margin impact of clearance discounts. That could put further pressure on Kohl's stock in the near term.
Still a solid company
While Kohl's is likely to report ugly results in the near term, it should be able to reduce inventory to match demand by year-end. That would position it to begin an earnings recovery in 2023 even if demand remains weak by comparison to 2021 (and 2019, for that matter).
The rollout of Kohl's in-store Sephora boutiques will also help mitigate weaker demand for casual apparel and home goods. Demand for beauty products is soaring as anti-virus masking becomes less routine. Additionally, since beauty products are replenishment items, the Sephora shops should drive consistent traffic to Kohl's stores.
Kohl's opened 200 Sephora shops last year. It is opening another 400 in 2022 and plans to open at least 250 more in 2023. Most of this year's openings are occurring this quarter or early in the third quarter. That could help Kohl's stabilize sales trends in the second half of this year and return to growth within a year or two.
Too cheap to pass up
At its current price below $30, Kohl's stock looks like a tremendous bargain for long-term investors. Assuming its operating margin stabilizes in the 6% to 7% range (below the company's target), the retailer could generate annual net income of roughly $700 million to $900 million a few years down the road.
Kohl's is currently valued at less than five times the midpoint of that range, based on its recent market cap of $3.6 billion. Moreover, the company plans to launch a $500 million accelerated share repurchase next month and is evaluating selling some of its real estate to fund additional buybacks.
Factoring in share repurchases, Kohl's has a good chance of growing EPS to record levels of $10 or more by 2025. That makes the stock look like a fantastic bargain for patient investors. I bought more shares last week, and I expect to continue buying if the stock falls further in the months ahead.