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Takeaway: We think the activism case here is thin and suggested plans are unlikely to reverse the fundamental trend.

Reviewing the KSS activists’ campaign letter, there are a few good points on governance, maybe one on the business.  We don’t think the plan being presented is likely to fix the fundamental trend, there is a lot of earnings upside already priced into this stock. 

Reasonable Points:

  • Loyalty/discounting is confusing: We’ve made the argument in the past that KSS has a value proposition problem, in that a new person walking in off the street doesn’t see great value on the goods at the indicated price, you have to know the whole rewards/discounting process to actually get a decent deal relative to offerings of some competitors like TGT or Old Navy.  Fixing that might help comps, but it also probably puts some pressure on GM%.
  • 2019 Guidance shows poor oversight: The company had to guide down I think 4-5 times that year.  It was awful forecasting and expectation setting, does show some bad management/governance.  Though to be fair, that CFO is gone.
  • Amazon not working and not disclosing enough on it: Management probably should be more transparent here.  Afterall it gave up warrants to Amazon to scale the deal.  Our math said it would be unlikely to drive traffic relative to costs, that seems to be the case but company standing firm that it’s a positive.

Problem Points:

  • Sales leaseback opportunity:  The valuation the activists have laid out for the real estate seems extremely irrational.  We’d want to see the assumed rent for those associated leases and its impact on the P&L.  The real estate play was part of the bull case 4-5 years ago, yet the company was adamant that it wouldn’t increase value, and that’s when this real estate had a higher perceived market value than today.  Doing a big real estate transaction and using the capital for anything but reinvestment and debt paydown would likely put KSS on a bankruptcy fast track.
  • Commentary on margin trajectory seems to be ignoring the unavoidable dilution from ecommerce mix.
  • Talking about reducing inventory for protecting turns/lower markdowns:  The company executed a multi-year inventory/markdown management program in ‘standard to small’ from ~2016 to 2018.  This helped to offset ecommerce dilution.  It was done across ~2/3 the fleet where management felt it was feasible, so are the investors proposing they do something that has already been done.
  • Cut cuts: company went through 2 big rounds of SG&A cuts in 2020.  It underpays associates relative to competition.  If anything investment needs to ramp to remain relevant. 
  • No mention of credit. We wonder if the activists are fully aware of its importance and risk profile.
  • No mention of Sephora. We’d be curious to know if the activists consider that is a good move or a waste of capital relative to cash return to shareholder opportunity.
  • This stock is no longer heavily shorted. When the investors went activist on BBBY, short interest was ~50%.  With KSS it’s now down to 8%.  Also unlike with BBBY, it’s very hard to argue that this management team/board has been asleep at the wheel.  BBBY was just sitting still, buying back stock, getting paid way to much to do little to nothing.  KSS has been trying lots of new initiatives, and though we may not agree with them, it’s far from doing nothing and any knowledgeable retail investor knows KSS is in a difficult competitive and strategic market position.

We haven’t seen an activist campaign like this for KSS, but we have seen the big sentiment inflections over the years. Historically they have been great opportunities to get heavy on this name short side. We're being patient before this makes its way back up the best idea short list as Y/Y compares are about to get very easy and we are still in Macro Quad2, but there's as much good news and high expectations in this stock than we have seen in about 2 years.