Kohl's (KSS 0.55%) stock price tumbled 8% on Aug. 18 after the retailer posted its second-quarter earnings report. Its revenue declined 8% year over year to $4.09 billion, but it still beat analysts' estimates by $180 million. However, its adjusted net income plunged 63% to $143 million, or $1.11 per share, which missed the consensus forecast by a penny.

Kohl's also reduced its full-year forecast across the board. It had previously expected its revenue to rise 0%-1%, its operating margin to come in at 7%-7.2%, and for its adjusted EPS to decline 7%-12%. But now it expects its full-year revenue to decline 5%-6%, its operating margin to slip to 4.2%-4.5%, and for its adjusted EPS to plummet 56%-62%.

An EV charging station outside a Kohl's store.

Image source: Kohl's.

That shocking guidance cut indicates the company is still in serious trouble. But at $30, Kohl's stock only trades at about 10 times its adjusted EPS forecast for the year and pays a hefty forward dividend yield of 5.9%. Do that low valuation and high dividend make Kohl's an undervalued income play? 

Is Kohl's succumbing to the retail apocalypse?

Kohl's initially fared better than many of its brick-and-mortar peers during the retail apocalypse by staying away from malls with stand-alone locations, keeping its stores organized with simple "racetrack" floor plans, rotating its products quickly, and keeping its inventory levels low.

But over the past three years, the cracks started to appear. Kohl's net sales declined 1% in 2019, even as it tried to bring back shoppers by processing Amazon's returns and leasing out its floor space to Planet Fitness' gyms and Aldi's supermarkets.

Its net sales plunged 20% in 2020 as it temporarily closed its stores during the pandemic, but rose 23% in 2021 as it reopened those locations. A new store-in-store partnership with LVMH's (LVMUY 0.82%) Sephora, which launched in December 2020, also brought back more shoppers.

But over the past year, Kohl's sales growth decelerated, its inventory levels skyrocketed, and its gross margins contracted as its brief post-lockdown recovery ended.

Period

Q2 2021

Q3 2021

Q4 2021

Q1 2022

Q2 2022

Net Sales Growth (YOY)

31.4%

15.5%

5.8%

(5.2%)

(8.5%)

Inventories Growth (YOY)

1.3%

1%

18.4%

40%

47.6%

Gross Margin

42.5%

39.9%

33.2%

38.3%

39.6%

Data source: Kohl's. YOY = Year over year.

In Kohl's second-quarter report, CEO Michelle Gass blamed that worsening slowdown on "a weakening macro environment, high inflation, and dampened consumer spending, which especially pressured our middle-income customers." Those headwinds have been rattling the entire retail sector, but Kohl's seemed to fare a lot worse than many of its brick-and-mortar peers.

In their latest quarters, Walmart's (WMT 0.09%) domestic comparable store sales rose 6.5%, while Target's (TGT 0.76%) comps grew 2.6%. Meanwhile, Kohl's seems to be stuck in the same sinking boat as Bed Bath & Beyond(BBBY), which posted a 23% comps decline last quarter.

Where does Kohl's go from here?

Kohl's held talks to sell itself to Franchise Group for $9 billion earlier this year, but ultimately abandoned the deal on July 1. The company is now only worth about $4 billion -- and its market value could continue to shrivel as its near-term growth slows to a crawl.

Looking ahead, Kohl's will need to use steep markdowns to reduce its inventories and stabilize its sales growth. It's also counting on its partnership with Sephora to bring shoppers back to its stores -- but investors should remember that Sephora's store-in-stores couldn't save J.C. Penney either. If those turnaround strategies fail, Kohl's could need to shutter some of its 1,100 stores.

On the bright side, Kohl's is still firmly profitable. It recently approved a $500 million accelerated buyback plan -- which Gass said underscored a "steadfast confidence in Kohl's future" during the company's latest conference call -- and the company remains "firmly committed" to its current dividend.

There are better plays in the retail sector

Kohl's isn't doomed yet, but I wouldn't consider it an undervalued income stock before it stabilizes its sales and reduces its inventory levels. Its jarring guidance cut also strongly suggests that management doesn't have a firm grasp of the situation yet. So for now, I'd stay far away from Kohl's and seek out stronger retailers with better comps and earnings growth.