Bull of the Day: Kohl's Corporation (KSS)
As Amazon (AMZN) has decimated the traditional retail landscape with its popular online marketplace, we’ve been hearing about the imminent demise of brick and mortar retailers for years. Old habits are hard to break however, and especially in the apparel business, many customers continue to prefer an in-person shopping experience.
Savvy traditional retailers like Kohl’s Corporation (KSS) are actually adapting quite well to this new environment, restyling and re-sizing store locations and engaging in innovative partnership opportunities. Recent changes at Kohl’s allow the company to continue offering a wide variety of desirable brands in retail locations, and at prices that are competitive with online sellers.
Kohl’s calls the strategy to optimize retail locations “rightsizing” which means matching the square footage of stores to customer foot traffic and inventory needs. In some cases this means making the stores smaller, and stores that remain the same physical size still get optimized with new interior layouts but become “operationally smaller” through reductions in inventory and improved displays and fixtures.
Kohl’s also started a pilot program in to share five retail locations with Aldi Supermarket stores and recently added a plan to co-locate with 10 Planet Fitness Gyms.
These partnerships appear to be win-win situations in that they reduce one of the most significant cost for physical stores – rent - for Aldi and Planet Fitness, while encouraging more foot traffic for Kohl’s stores by being located next to businesses that still attract customers to physical locations and are naturally resistant to online competition.
The Planet Fitness partnership is also a good fit for Kohl’s renewed focus on Active/Athletic apparel which includes expanding into new categories like golf and outerwear. Active/Athletic sales at Kohl’s have doubled over the past four years and now make up 20% of business.
Kohl’s is also operating 13 experimental “Small Format” stores which – at 35,000 square feet – have 60% less physical space and also 60% less inventory than the standard size stores. The spaces are designed to be flexible and efficient and also serve as locations where customers can pick up (and exchange or return) purchases that they have made online through the company’s website.
These smaller stores will likely be key to Kohl’s partnership with the online giant itself – Amazon – in which Kohl’s will sell the Amazon Echo and other devices in 200 of their stores and also allow in person returns of products purchased on Amazon.
Returns and exchanges have remained a challenge for online retailers and many customers continue to prefer executing them in in person, rather than using the mail or shipping services. Kohl’s CEO, Michelle Gass describes the Amazon partnership (and specifically the returns initiative) as an opportunity for the two companies to “leverage each other’s strengths.”
After a difficult end to 2018 – along with the rest of the equity markets - a series of recent earnings beats has Kohl’s shares rising again, and future estimates continue to rise. All 10 of the analysts who’s coverage is included in the Zacks rank for Kohl’s have raised their expectations for the current fiscal year in the past 60 days, earning the innovative retailer a Zacks Rank #1 (Strong Buy).
The shares still trade at a forward P/E ratio of less than 12X (Compared to approximately 17X for the S&P 500) and also pay an attractive dividend yield of 3.75% annually.
The improved earnings situation at Kohl’s is due simultaneously to increased revenue expectations as well as an intense focus on cost controls. The company has maintained General and Administrative expenses below 28% of gross revenues for the past 5 years, preserving precious margins in an industry that has seen many costs balloon over the same period.
Initiatives like the aforementioned rent-sharing deals are evidence that management is creatively looking for business solutions that simultaneously hold down expenses and increase store traffic.
The Amazon partnership proves that not only is Kohl’s not threatened by the dominance of the world’s biggest retailer, they’re actually using it to their advantage – collaborating and creating synergies rather than competing head-to-head in unwinnable battles.
Arguably, the most important characteristic for management in an industry is the ability and willingness to adapt as the landscape changes.
Though the Retail sector has seen a unique set of challenges over the past few years, Kohl’s is clearly at the top of the heap when it comes to engineering novel solutions.
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