Keith added KSS to the Hedgeye Virtual Portfolio today on the short-side of what appears to be a world-class squeeze. While KSS may look cheap today trading at just above 9x 2013 consensus EPS, valuation is irrelevant at this point given the fundamental event risk we see throughout 2013.
Here are some factors that we expect will continue to weigh on performance:
- JCP isn’t the only mid-tier retailer ceding share of late – so too is KSS. We’re seeing the consumer shift increasingly to both the off-price channel as well as the dollar stores. In reality, some of these customers are gone for good while the balance will require incremental spending in the form of marketing, systems, and likely personnel to win back.
- To that end, with both sales and gross margins coming in light last quarter, KSS’ saving grace was to pull back on SG&A materially to salvage EPS. This suggests the prior point is not likely to turn near-term.
- KSS ended 1Q12 with the sales to inventory spread sitting near 3 year lows of -5% as operating margin compares become less favorable over the next 2 quarters and it implements EDLP. Additionally, KSS highlighted unit inventories +2% in June however May unit inventories were down -5% with dollar inventories +7%. We sense that the 7 point sequential swing in unit inventory growth into June implies an even greater build in dollar inventories. In light of sales running -2.6% in both May and June, it is likely the sales to inventory spread has deteriorated further headed into the last month of the quarter.
- Given June sales results, July will have to come in +6.5% in order to simply meet consensus expectations for a -1.3% Q2 comp (updated Q2 guidance provided after the May miss calls for a modestly negative comp). With compares easing into July, a +6.5% comp implies a 70bps deterioration in the 2yr trend but regardless, this is no ‘gimme.’
- FY11 Revenues grew 2.2% with E-comm accounting for 1.5% of the annual growth and new stores contributing 2 points to the top line. The core KSS business contracted. Dot.com is great, but KSS’ brands are simply not powerful enough to drive the top line long-term.
- Lastly, with TRADE and TREND levels of support at $44.26 and $47.87 respectively, it’s sitting at a point where the fundamentals and price mesh well within Hedgeye’s Risk Management framework.