The last time I saw potential in Kohl’s (NYSE:KSS) was two years ago, but since then it collapsed like a house of cards. For the last two years Kohl’s stock and Macy’s (NYSE:M) have fallen 75%. This is six times worse than the SPDR S&P Retail ETF (NYSE:XRT). Clearly there is something that Wall Street does not like about this company’s prospects. Nevertheless, today we are going to discuss a bullish trade in spite of the malaise.
Arguably brick-and-mortar retail has not recovered yet from the disruption that Amazon (NASDAQ:AMZN) caused. The problem for stocks like Kohl’s started over a decade ago when then online newcomer completely disrupted their business model. Many of the giant names back then did not adapt to what was coming and are now paying the price. Macy’s is perhaps the poster child for the bunch.
Up until recently Kohl’s had fared better, but that has changed. I polled friends and family who are frequent shoppers there, they all feel that management went out of touch with the clientele tastes. They all agreed that they loved the discount and Kohl’s-cash strategy, but they find nothing they wanted to buy there anymore.
If this is the problem then it is fixable and I think management can and will figure it out.
Kohl’s Stock Is Struggling, but Therein Lies the Opportunity
Meanwhile, KSS stock is struggling to hold levels it hasn’t seen since 1997. The novel coronavirus crisis hit the entire world hard and all businesses had to shut down for extended periods of time. A blow this big takes time to heal, but it takes a heavier toll on companies that were already struggling to start.
The good news is that the shock from the quarantine was so big that it is likely to be the biggest thing in the forecast for a while. Therefore it is safe to assume that the Kohl’s stock lows this year should hold for a while.
This is not the same as saying I expect big rallies, because as they say, expecting the same outcome when nothing has changed is the definition of insanity. The best way to trade a bruised stock like this is to sell downside risk against what other people fear and against proven support.
In this case, KSS stock has buyers lurking above $12 per share. This means that investors can sell bullish puts or put spreads below that and realize profits. Those willing and able to own shares at or below $10 per share can sell the January $10 put and collect 85 cents for that. The worst that could happen is that they get put the stock at which point their break-even would be $9.15 per share. In the long-term this should be an acceptable risk given that price would have to fall 55% for the investor to lose money.
Best case scenario this trade generates income out of thin air. The level at which traders sell the put depends on the risk appetite. Selling the $12.50 put is the more aggressive position that can generate more income but with slightly lower odds of success.
Cheap Can Get Cheaper
Valuation is tricky since the traditional metrics are skewed as a result of the shut down. Case in point: California just reversed its reopening process and many of the businesses now have to close their doors again. This can only mean that the profit-and-loss statements remain misleading to investors. Value becomes in the eye of the beholder and it is more art than science at this point.
On paper, Kohl’s stock still has a price-to-earning ratio under 40, which is absolutely cheap. This doesn’t mean that the stock is not a value trap as cheap can definitely get cheaper too often to ignore.
Management has been spotty because it has shown periods of brilliance and some other stints not so much. From that perspective they are due for a good jag rather than a bad one. But therein lies the subjective judgment on behalf of the investors.
Conviction is scarce these days so trade size should remain small. This is not like we are buying a bottom in the stock market. We have tremendous weakness in some pockets and extreme exuberance in others. This doesn’t happen often and it’s new territory for all the experts. The assumptions have to be realistic and open to being wrong.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.