Buy Kohl’s as Earnings Underscores That Retail Is Back

KSS stock will rebound because second quarter numbers were that good

Stocks to Buy: Kohl's (KSS)

Source: Hailey Pollard via Flickr

Off-price retail giant Kohl’s (NYSE:KSS) recently reported stellar second-quarter numbers which beat top- and bottom-line expectations and included a lift to the full-year guide.

KSS stock traded slightly down early on the news, though it has since recovered. But that dip was mostly because KSS stock had come very far, very fast heading into the print. The post-earnings sell-off was just a minor normalization.

Bigger picture, Kohl’s strong second-quarter report affirms that retail is back. Across the board, traditional retailers have reinvented themselves to compete in today’s dynamic and omni-channel commerce marketplace. Moreover, the economy is healthy, the consumer is strong, and everything seems to be coming together at the right time for retail stocks.

I think this retail rally has legs. Between names like Kohl’s, Nordstrom (NYSE:JWN), Macy’s (NYSE:M), Walmart (NYSE:WMT), Target (NYSE:TGT) and a handful of small mall retailers, I think this retail rally still has healthy upside potential into the end of 2018.

Kohl’s Quarter Was Really Good

Despite the negative stock price reaction, Kohl’s second-quarter earnings report was really good.

Revenues topped expectations. So did earnings. The full-year guide got a nice lift. Comparable sales rose 3.1%, better than expected and in line with what Macy’s and Nordstrom reported (both in the 3% to 4% range). Gross margins were up, continuing their multi-quarter rebound. Operating margins were up, too, and profits soared.

Overall, it was a really strong quarter for Kohl’s.

KSS stock initially dropped on the good news simply because this stock needs to take a breather. Heading into the print, KSS stock had rallied 110% over the past year. The valuation had shot up to 14X forward earnings, which is big for this retailer relative to historical standards.

In other words, KSS stock was already priced for a beat-and-raise. We got that beat-and-raise. Now, investors are selling the news. But, because the fundamentals on KSS are strong, this sell-off will end and the uptrend will resume. Indeed, I think KSS stock is fairly valued around $85, assuming healthy revenue growth of around 1% over the next several years alongside slight margin improvements.

Retail Stocks Look Good Here

Beyond Kohl’s, the rest of the retail sector looks good here, too.

Walmart and Target are reporting numbers that are as good as they’ve been in a decade. In each of their most recent quarters, Walmart reported its best comparable sales growth in 10 years, while Target reported its biggest traffic growth in 10 years.

Meanwhile, the big three department stores (Macy’s, Nordstrom and Kohl’s) appear to be getting their groove back. All three reported comparable sales growth in the 3% to 4% range last quarter, while margins are steadily improving across the board.

The rally has even extended to the smaller players. Stocks like Abercrombie & Fitch (NYSE:ANF), American Eagle Outfitters (NYSE:AEO) and Urban Outfitters (NASDAQ:URBN) are all up more than 140% over the past year, thanks largely to positive comparable sales growth and margin expansion.

Part of this retail rally is due to the healthy economy and strong consumer (retail sales are up a robust 6% over the past three months). Part of this rally is also due to traditional retailers building out an omni-channel presence and being more competitive in the e-retail space.

Both of these tailwinds should persist. There are no signs that the consumer is weakening, and big summer spending usually leads into big holiday spending. Plus, across the board, e-commerce growth at traditional retailers remains quite strong.

Thus, this retail stock rally isn’t over just yet. There will be normalization periods (like we have seen with KSS stock and M stock), but the bigger story is that these stocks will continue to be winners.

Bottom Line on KSS Stock

Much like Macy’s, KSS stock got ahead of itself in the near-term, so the stock sold off on even great results. But, the fundamentals are strong, and the valuation implies further upside. Thus, KSS stock will rebound from here, and head higher into the end of 2018.

As of this writing, Luke Lango was long M, ANF, and AEO. 

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