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Jjust a few months ago, the stock of Kohls (NYSE: KSS) was rising high as a slew of bidders were bidding up to $70 per share to buy the retailer. However, following a disappointing first quarter earnings report and lower guidance, most of Kohl’s suitors lost interest.
But hopes the company can still strike a deal with franchise group (NASDAQ: FRG) limited damage to Kohl’s stock at first. Over the past month, however, growing signs of a pullback in discretionary spending have undermined the proposed deal. On July 1, Kohl’s officially announced that it had ended its strategic review process and would remain public.
This sent the shares down to under $30 from around $60 in April. But while 2022 is shaping up to be a tough year for the department store giant, its long-term outlook remains bright. As a result, I am taking advantage of this sharp pullback to buy more Kohl shares.
Reduced and canceled offers
In April, Franchise Group, which owns brands such as Vitamin Shoppe and Pet Supplies Plus, expressed interest in buying Kohl’s for $69 a share. At the time, he was one of several bidders offering between $65 and $70 for the company.
Unfortunately, high inflation, rising interest rates and general market turmoil made it difficult for most bidders to secure financing. To make matters worse, Kohl’s released a weak first-quarter earnings report in May. The company said adjusted earnings per share (EPS) fell 90% year-over-year in the quarter and cut its full-year EPS guidance by about 8%. This caused all but two bidders to drop out.
On June 6, Kohl’s announced that it had entered into a three-week exclusive negotiation period with Franchise Group to confirm a revised offer of $60 per share.
However, Kohl’s sales trends continued to deteriorate in June. Franchise Group reduced its offer again (to $53) and still had no firm financing in place. Kohl’s board of directors concluded that selling the business did not make sense in the current environment and terminated negotiations.
More turbulence to come
In the press release announcing the end of the strategic review, Kohl’s acknowledged that demand had slowed in the past month. The company now expects to post a single-digit sales decline this quarter, compared to its previous guidance of a single-digit decline.
Kohl’s has not updated its earnings forecast, but slowing sales will likely force it to implement margin-squeezing discounts to eliminate excess inventory, similar to rivals such as Target.
Analysts cut their full-year EPS estimates to $4.96 on average, well below the company’s most recent guidance range of $6.45 to $6.85. I wouldn’t be surprised if management were to cut its full-year EPS guidance to well below $5 due to the margin impact of clearance rebates. That could put additional pressure on Kohl’s stock in the near term.
A still solid company
While Kohl’s is likely to report poor near-term results, it should be able to reduce inventory to meet demand by the end of the year. This would position it to start an earnings recovery in 2023 even if demand remains weak compared to 2021 (and 2019, for that matter).
The rollout of Kohl’s in-store Sephora stores will also help mitigate the decline in demand for casual wear and homewares. Demand for beauty products is skyrocketing as virus hiding becomes less routine. Additionally, since beauty products are restocking items, Sephora stores should drive consistent traffic to Kohl stores.
Image source: Kohls.
Kohl’s opened 200 Sephora stores last year. It will open another 400 in 2022 and plans to open at least 250 more in 2023. Most openings this year are this quarter or early in the third quarter. This could help Kohl’s stabilize sales trends in the second half of this year and return to growth within the next year or two.
Too cheap to pass up
At its current price below $30, Kohl’s stock looks like a huge bargain for long-term investors. Assuming its operating margin stabilizes in the 6-7% range (below company target), the retailer could generate annual net income of around $700-900 million by a few years.
Kohl’s is currently valued at less than five times the midpoint of that range, based on its recent market capitalization of $3.6 billion. Additionally, the company plans to launch an accelerated $500 million share buyback next month and is considering selling some of its real estate to fund additional buybacks.
Factoring in share buybacks, Kohl’s has a good chance of growing EPS to record highs of $10 or more by 2025. That makes the stock a fantastic bargain for patient investors. I bought more stocks last week, and I expect to keep buying if the stock drops further in the coming months.
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Adam Levine-Weinberg holds positions at Kohl’s. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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