Kohl’s Corporation Stock Highlights Why the Retail Sector Is in Trouble

It might not look like it, but Kohl’s Corporation (NYSE:KSS) stock actually has performed pretty well over the past few years. It’s true that the KSS stock price has declined 14% over the last five years, but, including dividends, Kohl’s stock has provided a modestly positive return over that period.

Kohl's Corporation (KSS) Stock Highlights Why the Retail Sector Is in Trouble

More recent investors in KSS stock are in the red. But looking at the department store space, it could be much, much worse. Over five years, Nordstrom, Inc. (NYSE:JWN) has declined 26%. Macy’s Inc‘s (NYSE:M) equity value has been cut in half. The worst of the bunch, J C Penney Company Inc (NYSE:JCP) and Sears Holdings Corp (NASDAQ:SHLD), are down 81% and 89%, respectively — and neither stock has paid a dividend over that period.

Kohl’s has earned its relatively good stock performance by staying aggressive — and by avoiding struggling malls. The company made a major deal with Under Armour Inc (NYSE:UAA, NYSE:UA) and signed an innovative partnership with Amazon.com, Inc. (NASDAQ:AMZN), which led my InvestorPlace colleague Luke Lango to declare KSS stock a buy back in September.

Coming out of the company’s third quarter report earlier this month, however, I’m not quite as confident. Looking forward, I do think the KSS stock price has a good chance to continue to outperform its sector — but that’s not enough to make Kohl’s stock a buy, as the past few years have proven. Much like T-Mobile US Inc (NASDAQ:TMUS), I see Kohl’s as a strong company in a difficult industry.

In fact, Kohl’s stock seems to epitomize the challenges facing the sector. And those challenges still seem too great to turn bullish on KSS.

Is Kohl’s Stock Cheap Enough?

The Kohl’s stock price sits right at 12 times the midpoint of the company’s earnings-per-share guidance for this year, excluding an expected one-time tax benefit in the fourth quarter.

It’s a cheap multiple — one that suggests stable performance is good enough. Zero growth going forward probably does little for the KSS stock price, but it’s enough to maintain a juicy ~5% dividend yield, with optionality going forward if Kohl’s can jump-start growth.

The problem in retail is that flat revenue doesn’t turn into flat profits. Key costs like rent and labor rise over time. Generally, a retailer needs at least 2% same-store sales growth — and often 3% or greater — to keep margins intact and drive even modest profit growth.

In this environment, where comps are negative at many brick-and-mortar retailers, Kohl’s performance is better than most. But a 0.1% increase — even considering the 35-basis-point-impact from storms cited on the Q3 conference call — isn’t good enough. Nor is the -1% year-to-date or the -2.4% figure from fiscal 2016.

It’s a sign of just how dramatic the change in U.S. retail has been that any positive comp seems decent. On a relative basis, positive might seem solid — but it still suggests a long-term decline in profits. And ~12x EPS seems expensive in that context.

Cyclical Risk to KSS Stock

Now, it’s certainly possible the trend will improve in the near term. The Amazon deal should help foot traffic. Kohl’s own online business grew 15% in the quarter. The company seems better positioned than most of its peers — and possibly in line to pick up market share being lost by those declining rivals.

But there’s another broad risk to retail as a whole — and to Kohl’s more specifically. By most measures, the economy is reasonably strong — and has been for a while. This is the ninth consecutive year of economic expansion, the most since 1991-2001.

What happens to KSS — and the sector — when that inevitably changes? Kohl’s sales and profits are declining at a time when the economy, overall, is growing nicely. Given the thin margins in retail and the impact of fixed-cost deleveraging, Kohl’s profits will tumble — and likely take KSS stock with them.

Even if Kohl’s can drive an extra 2 or 3 points of comp growth and get profits flat to modestly up, it probably won’t be enough from a long-term standpoint. Kohl’s likely needs to grow earnings enough to provide a cushion for the next cyclical downturn.

And that seems to be asking too much.

The 5% dividend here is nice, performance is decent, and KSS stock isn’t expensive. It’s a modestly enticing combination. But any real upside seems difficult to achieve, and that 5% yield is accompanied by a fair amount of risk, both near-term and long-term.

Kohl’s has done a nice job, but its stock still has declined over the past five years. What concerns me at the moment is the odds of that continuing over the next five years.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2017/11/kohls-stock-highlights-trouble/.

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