Department store company Kohl's (KSS +1.62%) is going into the holidays needing to prove that it can return to growth. Sales at its stores have been in decline, profits have been falling, and the company has struggled to increase store traffic. Kohl's has launched a variety of initiatives in an effort to right the ship, and I recently discussed a few reasons Kohl's stock could rise as a result. But there are also some long-term risks facing Kohl's, and these could lead the stock price lower.
Retail traffic may be in permanent decline
Kohl's, like many retailers, has been suffering from declining traffic in its stores. Part of this is probably Kohl's fault; the company pushed its private-label brands too hard during the past few years, and the lack of national brands likely drove some customers away. But a bigger problem, and one that won't be as easy to reverse, is the persistent decline in the number of store visits by the average consumer.
E-commerce has fundamentally changed the retail industry, and with online sales growing far faster than retail sales as a whole, there may simply be too many retail stores fighting for too little traffic. Some retailers have started closing down significant numbers of stores: Sears plans to close 235 stores by the end of this year, and Office Depot is set to shutter more than 400 stores over the next few years. Kohl's operates roughly 1,200 stores in the United States, a number which may simply be too big, and the company may eventually need to close some stores if these traffic trends don't reverse.
Kohl's does have an online business as well, but it only accounted for about 8.5% of its total revenue in the most recent quarter. While online sales are growing quickly, any weakness in the stores will continue to overwhelm this growth for a long time. With no sign of retail traffic recovering any time soon, Kohl's could be facing serious problems for many years, and that could lead to the stock having serious problems as well.
Growth initiatives could fail
Kohl's has launched a few programs in an effort to reverse these negative traffic trends, and so far, they appear to be working. Kohl's new loyalty program, which was launched nationwide in October, was successful in its test markets, leading to rewards customers making two additional trips to Kohl's each year on average. Kohl's new beauty department has had a similar effect, driving repeat visits, and Kohl's plans to roll this out to 400 additional stores next year.
But these initiatives aren't really different from what other department stores are doing. J.C. Penney (JCP +0.00%) has been installing Sephora boutiques within its stores, and these have been one of the biggest bright spots during an otherwise difficult period for the company. Penney also has its own rewards program, and it's actually more generous compared to Kohl's program, handing out a $10 reward for every $100 spent instead of the $5 Kohl's gives out.
Kohl's isn't really doing anything differently, and while that's not necessarily a bad thing if the company can execute better than the competition, there's no guarantee that loyalty and beauty will continue to drive the same results as they did during their test runs. If these initiatives fall short, Kohl's traffic woes will likely continue, and the stock could decline as a result.
Online sales could mean lower margins
Eventually, online sales will make up a greater portion of Kohl's total sales, and while this is a necessary development, it could mean lower margins across the entire industry. Kohl's has managed operating margins in excess of 10% in seven of the past 10 years, but online retail could completely destroy the advantages the company once enjoyed.
Part of Kohl's success has been the result of building its stores in off-mall locations, away from direct competitors like J.C. Penney and Macy's. Conversion rates at Kohl's stores are higher simply because consumers can't easily walk to a competing store like they can in a mall, and with malls losing popularity among consumers, the strategy appears to be prescient. But online retail renders this advantage irrelevant, and as Kohl's looks to sell more online, the company will be on even footing with all of its competitors.
Kohl's bricks-and-mortar business is far from dead, of course, and shopping for apparel in stores as opposed to online will always be preferable for plenty of consumers. But online margins are unlikely to ever match those from Kohl's stores, and the days of 10%-plus operating margins for the company could very well be over. That's bad news for the bottom line and that may play out in the stock price.
