Retail stocks are getting slammed and they’re taking the whole market down with them, as the major indices head toward the worst-performing week we’ve seen since August. An earnings miss from Macy’s (M) — which was down more than 20% last week — kicked off the selling wave last Monday, and concerns about weak retail sales for the upcoming holiday season continue to weigh on department store stocks.
But, I haven’t lost all hope in retail. In fact, I’ve been keeping a very close eye on Kohl’s (KSS), which had been weathering the storm up until Friday’s 6% dip. There’s a tougher competitive environment for department stores, but KSS’ strong Q3 earnings last week exemplify that the right merchandise, pricing and customer loyalty programs can lead to solid results.
With 50% of online sales coming from mobile, KSS also has a strong online presence, which will be key to retail success in the coming months and years, as well as strong growth for Kohl’s stock.
The company easily beat estimates, with earnings of 75 cents per share coming in higher than last year’s 70 cents per share, and 6 cents better than expected. Comparable store sales increased 1%, marking the company’s fourth consecutive quarter of increasing comparable store sales. Strength in women’s apparel, children’s apparel and activewear led the gains, while earnings comparisons benefitted from a 5.5% reduction in the outstanding share count as the company continues to aggressively buy back its stock.
Kohl’s management is expecting to grow comparable store sales 2%-3% in the fourth quarter, which I believe is a bit ambitious. However, if the company’s extra marketing spending proves to be effective, it certainly could be possible. Management also expects free cash flow of $800 million, which is lower than I anticipated, as a result of higher ending inventories — but that should reverse in 2017.
Still, $800 million in free cash flow represents a 10% yield on KSS’ $8 billion market capitalization. Longer term, the company maintains its confidence that its “Greatness Agenda” will drive further improvements.
Despite Friday’s dip — due mostly to weak sales from Nordstrom (JWN) — the so-called “death of department stores” has been greatly hyperbolic. I think it’s important to note that some of Macy’s issues are truly limited to just Macy’s.
I have a hunch the moves right now are being exaggerated by hedge funds trying to make sure the performance of department store stocks is strong for the year’s end, and I also think that results are being hampered by unseasonal weather and a lack of a strong fashion cycle.
While Kohl’s stock got caught up in the sector sell-off, I remain confident that it will outperform over the next year. The stock’s 4.15% dividend yield doesn’t hurt, either.
In an overall market environment where stocks aren’t that cheap, department store stocks offer significant value. Many of these stocks can boast impressive 10% free cash flow yields thanks to their depressed prices, which means they’re far too cheap to sell in this market environment. I think once we get past the Christmas season and reset earnings for 2016 to realistic levels, the group should outperform.
Hilary Kramer is the editor of GameChangers, Breakout Stocks Under $10, High Octane Trader, Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.
