Could Kohl’s Stock Continue to Fall?

Kohl’s (KSS) stock has dropped 24.9% so far this year. Department store peers Macy’s (M) and Nordstrom have declined 47.5% and 16.6%, respectively, YTD (year-to-date). JCPenney (JCP), one of Kohl’s direct competitors, has gained 5.8% since the beginning of the year. Kohl’s has underperformed the benchmark S&P 500 Index, which is up 27.3% YTD.

Kohl’s stock has fallen about 14.7% since the company announced its third-quarter results in November. Its third-quarter sales lagged the analysts’ estimates. The company also issued a dismal outlook for fiscal 2019. However, the retailer’s comparable sales grew marginally during the third quarter after declining in the first two quarters of fiscal 2019.

Kohl’s weak Q3 earnings

Kohl’s third-quarter net sales declined by 0.25% YoY to $4.36 billion. Analysts estimated its net sales to grow by 0.69% to $4.4 billion. The company’s comparable sales grew 0.4%.

JCPenney reported a decline of 9.3% in its third-quarter comparable sales. The company cited a highly promotional environment as a key challenge. Macy’s reported weak third-quarter earnings with its net sales down 4.3% YoY at $5.17 billion. Its comparable sales fell 3.5% while its adjusted EPS declined 74% YoY to $0.07.

The drop in Kohl’s reported EPS was steeper, falling 24.5% YoY to $0.74 compared to analysts’ estimate of a 12.2% decline. These lower margins impacted Kohl’s earnings. The company repurchased 2.7 million shares during the third quarter. It plans to repurchase shares at the top end of the $400 million–$500 million range.

Kohl’s margins fell under intense competition

The retailer saw contractions beyond its expectations in the margins. Its gross margin declined by 67 basis points YoY to 36.3%. Aggressive competitive pricing to confront online and off-price rivals led to this contraction. Higher shipping costs associated with increased digital sales also hurt its gross margin.

The company also cited an unfavorable mix due to weak performance in the women’s category as a reason for the gross margin contraction. The company’s comparable sales for the women’s category fell 1% during the quarter. However, off-price rival Ross Stores (ROST) experienced a strong performance in the women’s category during the same period.

Kohl’s operating margin also contracted during the third quarter, falling over 120 basis points YoY to about 4.7%. A lower gross margin and deleverage in SG&A (selling, general, and administrative) expenses impacted the operating margin. Higher store and marketing expenses, costs related to various brand launches, pre-holiday season hiring, and costs related to the Amazon (AMZN) returns program subdued its operating margin.

Increasing competition and counter-initiatives

Kohl’s and other department stores have been facing tremendous pricing competition from off-price retailers like TJX Companies, Ross Stores, and Burlington Stores. These off-price retailers offer comparable merchandise at deeply discounted prices. At the same time, brick-and-mortar retailers have been trying to confront challenges posed by online retailers like Amazon.

In 2017, Kohl’s introduced the Amazon returns program to accept returns of purchases from Amazon in selected stores. The company initiated this program to capture higher customer traffic by accepting merchandise returns from the e-commerce giant. Kohl’s extended the returns program to cover all of its stores in the first quarter of fiscal 2019. However, the costs to support the Amazon returns program, as well as the related coupons and offers, are weighing on the company’s margins.

Kohl’s has been trying various initiatives to maintain its customer traffic. Earlier in the year, it inked a deal with Planet Fitness to lease out space adjacent to its stores.

As part of these efforts to increase customer traffic, the retailer continues to invest in growth categories like home division and activewear. It has increased the presence of the Adidas shop in-stores to 175 store locations.

Kohl’s has expanded the space for the active category in 160 of its high-performing stores. The retailer launched Under Armour Plus and Adidas besides the existing assortment of Nike Plus to enhance its women’s plus category.

Meanwhile, to improve its offering within the home division, it launched brands like Koolaburra by UGG Homes and Scott Living. Scott Living is Kohl’s exclusive partnership with brothers Jonathan and Drew Scott, hosts of HGTV’s Property Brothers, to offer modern home décor.

Dismal outlook

During its third-quarter earnings, Kohl’s revised its EPS guidance for fiscal 2019. It lowered its fiscal 2019 EPS guidance to $4.75–$4.95 against the earlier estimates of $5.15–$5.45. Analysts forecast its fiscal 2019 adjusted EPS to drop 13.6% YoY to $4.84.

Meanwhile, the company expects an enhanced promotional environment to continue and impact its margins and bottom line. It sees a contraction of around 60–65 basis points in its fiscal 2019 gross margin. The company projects its comparable sales growth in the -1.0% to -1.5% range. However, it expects comparable sales growth in the fourth quarter in the range of flat to 1%.

Analysts’ recommendations

On December 16, Kohl’s stock carried a “hold” recommendation from 12 out of 19 analysts. The stock had a “buy” rating from five analysts, while two analysts had a “sell” recommendation. Currently, analysts’ average target price of $50.24 implies a potential upside of 0.9% in Kohl’s stock over the next 12 months.

The company’s fourth-quarter performance, which included holiday sales, would reflect the effectiveness of its growth strategies.