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Morningstar | No-Moat Kohl’s Opens 2019 With Soft Sales and No Momentum; Shares Undervalued

No-moat Kohl’s reported negative 3.4% same-store sales in the first quarter of 2019, well short of our forecast of 0.5%. Weak areas included women’s apparel and seasonal product. Costs also disappointed, as sales, general, and administrative expenses as a percentage of revenue of 31.2% came in 80 basis points above our forecast. We think Kohl’s spent heavily on marketing initiatives (such as Kohl’s Cash) in the quarter to overcome poor store traffic related, in part, to competitors’ discounting of post-holiday inventory in February. Kohl’s adjusted EPS of $0.61 missed our forecast of $0.68. Moreover, Kohl’s reduced its 2019 EPS guidance to a range of $5.15 to $5.45 from its early-March guidance of $5.80 to $6.15. We believe sales weakness in key areas has extended into the second quarter. Also, the proposed expanded tariffs and the nationwide rollout of wide-moat Amazon returns could increase costs. We expect to lower our 2019 EPS forecast from our prior estimate of $6.09 by approximately $0.75. We also expect to reduce our fair value estimate of $76 by a single-digit percentage. We have not, however, changed our expectation of flat long-term same-store sales and 7% operating margins. We view shares as attractive even after a decline of more than 12% on the first-quarter report.

Kohl’s long-term plans show progress as first-quarter digital sales increased by a high-single-digit percentage. We maintain our view that Kohl’s main problem is weak store traffic. However, we think merchandising improvements (new plus-size clothing) and expanded floor space for athletic brands will help. Kohl’s highlighted athletic apparel as a bright spot in the first quarter. Also, we think the Amazon partnership will attract some shoppers. Kohl’s has not released any financial results related to the deal, but we think results in test markets were encouraging. We believe, however, that Kohl’s will incur expenses as it hires staff to provide the service and covers logistics costs.

We think the outlook for the second half of 2019 is better the first, but the trade situation remains a concern. While we do not think tariffs on imports from China have been a big issue for Kohl’s so far, expanded tariffs could affect 20% of its inventory. The firm is dependent on products which are often manufactured in China, including home furnishings, accessories, and apparel (about 72% of sales). The impact of tariffs is uncertain, but likely transitory.