If you’re looking for a viable value play in the retail sector—one with excellent dividend growth potential and strong starting yield, then you’ll definitely want to read today’s Wicked Capital company analysis of Kohl’s (KSS).
This analysis was performed for our Wicked Capital passive income portfolio (PIP) that we share on our site with you. There are some key reasons why I’m conducting this analysis and I wanted to quickly share the reasoning behind it and how it fits into our portfolio strategy for our PIP.
First, there is one industry or space that we currently lack exposure to in our portfolio. It’s a space that I have been looking to add a position in but struggling to make a decision—retail. I know, it’s the scary 6-letter word right! But we definitely have some room in our PIP consumer discretionary sector pie to add this exposure if we can find the right risk-reward opportunity.
Second, I’m looking for deep value with an attractive starting yield—along with, of course, quality and the potential for an even stronger yield-on-cost (YOC) long-term.
Yes, there’s Walmart. But with a starting yield of 2.07%, that won’t work for us. Then there’s Target. A better starting yield at 3.3%… but still not what I’m after. A quality company for sure—just not the value and yield that I’m seeking right now for this addition.
The search had been ongoing for some time… and then I landed on Kohl’s (KSS). Now, I love Kohl’s. In fact, I buy almost everything I wear at Kohl’s—at a deep discount and with that bonus Kohl’s cash. And while that peaks my interest in the company from a customer perspective, it also means that it’s time for another Wicked Capital deep-dive analysis.
Following its recent earnings performance and subsequent nose-dive in price. The question becomes… is this a great value opportunity or just a really bad value trap?
Let’s get our company analysis started and find out…
Founded in 1962 (with an IPO in 1992), Kohl’s Corporation (Kohl’s) is an operator of department stores—more than 1,100 of them in 49 states, as well as their ecommerce website and a handful FILA outlets and Off-Aisle clearance centers.
They sell moderately-priced private label and national brands (e.g., Nike, Levis, Under Armour, Carter’s, Dockers, KitchenAid, FitBit, and NutriBullet) including apparel, footwear, accessories, beauty and home products. This lineup includes items available in stores and exclusively online through their website. The company also has exclusivity agreements with the Food Network, Jennifer Lopez, Marc Anthony, Rock & Republic and Simply Vera Vera Wang.
Kohl’s focus is on providing value to families through an outstanding customer experience—both in-store and online. This includes an emphasis on rewarding their customers with savings opportunities (think Kohl’s Cash). They also have placed a high priority on driving traffic to their physical stores and Kohls.com. Furthermore, they have recognized the shift in customer demand for in-store pickup and have taken steps to leverage their stores as fulfillment centers.
Additionally, they have recognized the shift away from malls and are well-positioned to capitalize on the consumer desire for neighborhood shopping—67% of their stores are in strip centers and 26% are freestanding.
Finally, they have built a community of over 30-million rewards members and Kohl’s credit card holders.
In our opinion, Kohl’s marketing (especially in terms of social, digital and mobile) and ability to understand and connect with their customer at a deep level is a competitive advantage–whether it is sustainable remains to be seen.
Kohl’s revenues have produced a roughly 1.5% CAGR over the past 4 years. This is obviously not the kind of growth we would typically be looking for; however, gross margins have been steadily improving—resulting in a much stronger CAGR for EPS.
In terms of profitability, Kohl’s has a strong operating cash yield of 135.5% and a reasonable—when compared to the industry—net margin of 3.9%. The company’s performance metrics are solid as well: 14.6% ROE, 5.8% ROA and 7.2% ROI.
Kohl’s has a current debt-to-capital ratio of 38% (very comfortable) and a 2.3 interest coverage (not excellent, but not horrible either).
It is important to note that leadership has placed a high-degree of emphasis on reducing debt through debt repurchasing—including $943 million in 2018. This has brought their adjusted debt to EBITDAR down to 2.16 from 2.64 in 2016, further strengthening their balance sheet.
We analyzed a lot of other factors, but the above represent a fair and accurate summary of our findings. From a quality perspective, Kohl’s checks most of our boxes—the chief concerns being increased competition and low revenue-growth potential (hence the market’s negative reaction). However, we feel they are fundamentally well-positioned for strong performance over the long-run.
Before looking at the value proposition, let’s take a look at Kohl’s dividend performance (not a primary trigger for us, but an important indicator).
The company’s first dividend was declared and paid in 2011. We fully acknowledge this is by no means a long history. However, let’s (1) take a look at their track record over those 10 years and (2) remember that we place a much greater emphasis on recent, current and future performance than long-run, rearward-looking historical data (read “4 Ways Factor Exposure Can Improve Your Dividend Growth Investing“).
When we look under the hood, what we find is that Kohl’s has produced an impressive 13% dividend CAGR over those 10 years… and a 5-year dividend CAGR of 11.4%, with consistent increases. And it has an attractive current starting yield of 5.25%.
This performance is no surprise when you consider that the company prides itself in implementing a:
They also have a low 53.4% payout ratio—providing plenty of room to grow in the future.
Accepting that it’s unrealistic to expect the company to maintain an 11.4% dividend CAGR, we arrive at the following potential yield-on-cost (YOC) projections based on just a 3.5% CAGR—one that is inline with their projected EPS growth (a very conservative approach):
Thus, our dividend analysis provides another positive checkmark. So, it’s down to value…
We feel confident that Kohl’s provides a reasonable level of value in our opinion. We are in this for the long-run, and believe, with cost-averaging and the company’s execution of its strategic plan, that it provides the kind of value we are looking for—good forward-looking value.
From a trailing PE perspective, KSS is significantly undervalued against both its own 5-year average (-11.9%) and the department store industry average (-82.5%).
From a forward PE perspective, KSS is also significantly undervalued against its own 5-year average (-26.8%) and the department store industry average (-84.2%).
We calculate (and yes, there are different ways to calculate PEG) that Kohl’s is, once again, significantly undervalued against its own 5-year average (-35.7%) and the industry average (-60.5%) based on a 2-year forward PEG (we prefer to use a 2-year CAGR estimate).
Either Kohl’s is a badly-broken company, or this is a textbook case of a massive market overreaction (compounded by sector rotation in the business cycle). Based on our fundamental analysis, we believe it’s the latter. Thus, we feel Kohl’s represents a tremendous deep value option—a solid company at a fire-sale price.
As recession and trade-war fears grow, the retail space (part of the consumer discretionary sector) is sure to be hit hard as money flows out of the sector. Add to this the intense competition in the space—including the likes of the big-guns Amazon, Walmart and Target.
But, as value investors, that’s when our antennas should perk up—we’re looking for value created by sector rotation and market overreaction. The key is identifying real value opportunities and avoiding value traps. We want fire-sale prices but not companies on fire.
We’re not saying things can’t get worse before they get better regarding Kohl’s stock performance—we just believe that it will get better. And when it does, it will provide strong YOC for our portfolio (and not to shabby of a starting yield either). As always, we have a long-term perspective as dividend growth investors.
How much worse can it get?
Based on technical analysis, we see KSS potentially bottoming in the $39-$44 range… $34 if things get bad… $24 if the proverbial SHTF and everything was getting dumped (the “baby with the bathwater” scenario). But at the same time, it could bounce from here tomorrow. We’re not in the “call tops and bottoms” business. Rather, as dividend growth investors, we’re in the value acquisition and risk management business—and retail is higher risk.
Our mission is to limit our portfolio risk by effectively identifying a price range at which a quality company (with dividend growth potential) will provide significant long-run value. If the markets are overreacting… they can keep on overreacting for longer than you or I may think. Never forget that! But, if we’ve correctly identified quality and value—the odds in the probabilistic system are in a favor that the stock will recover over time. There’s no guarantee and that’s the best we can do… and diversify our portfolios.
In the case of Kohl’s, our analysis gives us confidence that the risk-reward ratio makes this company, in this price range, a great position—one that we’re willing to initiate. We’ll gladly cost-average down to $34/share and then re-evaluate from there if needed. Ultimately, we believe KSS is a $60-$100 stock (our current target is $75) with great dividend growth potential long-term.
And we always aim to buy and hold forever, which is as long-term as you can get. So, we’ll buy the value we see the market handing us and wait… we have time on our side.
If you’re looking for a great value opportunity in the retail space—one with a strong current yield and excellent dividend growth potential, then Kohl’s may be for you. If so, we encourage you to take the time to do your own deep dive and analysis. Don’t ever take our—or anyone else’s—word when it comes to analysis. Fundamental analysis is subjective—meaning it’s as much an art as a science. Perform your own due diligence and see if you come to the same conclusion as we have.
Best wishes and good trading!
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