My favorite CEO quote for this dismal retail earnings season comes from Myron Ullman, chairman and CEO of J.C. Penney (NYSE:JCP). Commenting on third-quarter sales and earnings yesterday, he assured investors the company isn't doing anything wrong, noting, "It's not as if we got dumb all of a sudden."

I think the same comment applies in spades to Kohl's (NYSE:KSS), which also reported disappointing third-quarter results yesterday. Blame it on high oil prices, a warm fall season so far, a tapped-out consumer, or the fact that the Indianapolis Colts have lost two games in a row ... it all adds up to the same thing. Traffic is down across a broad swath of pretty savvy retailers like Macy's (NYSE:M), Bed Bath & Beyond (NASDAQ:BBBY), Nordstrom (NYSE:JWN), and Abercrombie & Fitch (NYSE:ANF); and they can't cut expenses fast enough to keep the bottom line moving upward like we are all used to.

By the numbers
Kohl's offered a comps preview for the quarter when it released October's same-store sales last week. Although comps were down 2.6%, the company eked out a 5% total sales increase, thanks to a larger store base. At 37.1%, gross margins have held up, but expenses grew faster than sales. However, it's not quite fair to say expenses "grew" that much -- instead we saw expenses de-leverage and operating margins improve. Earnings per share of $0.61 was down 10% from last year's $0.68.

Spotlight on inventory
As my esteemed colleague Rich Smith highlighted a few days ago, it's not just sales and earnings we should be concerned about this holiday season. Kohl's ended the third quarter with inventories 21% higher than the same time last year. With Kohl's guiding to comparable sales in the fourth quarter of flat-to-down-2%, we should expect overall sales up by the mid-single-digits.

It's going to be a real feat for the company to move through that much excess inventory on those sales. The stores are all dressed up for the holidays, but that inventory is going nowhere unless Kohl's turns into markdown city for the next nine weeks. Fortunately, I believe Kohl's management is too smart to follow the disastrous Dollar General "pack-away" strategy.

Taking your lumps and moving on
The one cardinal rule of retail is you must sell everything you buy. When you get too much inventory, the only real answer is to mark it down, take your lumps, and move on. Count on Kohl's doing this over the next nine weeks. Earnings will suffer and management knows this, as it lowered fourth quarter earnings guidance to $1.41-$1.51, below analyst current estimates of $1.58, and well below last month's estimates of $1.66.

Show me a silver lining ... please!
Is there anything to smile about amid all this doom and gloom? Yes ... two things. First, Kohl's will have a lot of customers this holiday who get good deals, making them happy, and luring them back in 2008. Second, as investors we get a chance to play some pretty attractive "pot odds."

I don't see this stock going higher in the near term. Once selling at $79, the stock can now be had for under $50. You can only sell high if you buy low, so Kohl's dip may provide a great opportunity to get in at an attractive price.

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