M, JCP, KSS - Why This Is Bad For Kohl's
This -5.2% comp number and additional 15% guide down to the 4Q earnings number is just icing on the cake for FY15 which can be characterized by a series of late cycle moves. Blue Mercury acquisition, off-price concept, entering the China market, etc. Do malls have a traffic problem? We think the answer is unequivocally yes, based on the 25% e-comm growth commentary that means B&M comps were down in the 10-12% range.
JCP on the other hand put up a relatively good number at 3.9%, held its EBITDA dollar guidance for the year and was more positive on its outlook for FCF generation.
SO, what does this mean for KSS. Based on the conversations we've had on the name the general consensus is that sales trends look ok based on credit card data. We should point out that KSS has 60%+ of its sales accounted for on it's own Private Label credit card (that's a black box), and non-credit has outperformed credit in 1Q and 2Q (no commentary given on the 3Q call). As KSS pushes it's Y2Y loyalty program it naturally inflates its national credit card data, which might explain the big shortfall we saw earlier in the year when the whisper was for a 4-5% and the company reported a 1.4%. Plus, it puts 25% of its EBIT at risk.
Bigger picture we've seen KSS out comp M in each of the past 4 quarters by an average of 2.6% that accelerated to a spread of 5% in 3Q. On the flip side, JCP has out comped KSS for the past two years by an average of 4.4% as it recaptures some of the $1bil in sales it ceded in market share to KSS. That suggests a flat to down comp for KSS. We don't typically call out weather, but as we lap two exceptionally cold ones with 70 degree weather in December here in the Northeast, it's hard to see how KSS runs from the same issues hurting M who attributed 80% of the comp decline to above average temperatures.
We want to be as clear as day on our positioning here – we would absolutely bet against the ‘it’s a great cash flow’ story, and would short it today into strength. We think that earnings will fall by $1.50 from here, which will threaten management’s ability to buy back stock and ultimately, threaten the dividend. Once cash flow support goes away, then we’re left with KSS trading at 7-8x $2.50 in EPS, which leaves us with a stock in the high teens. Yes, it will take a number of years for this to play out. But if you’re tempted to chase this ‘cheap’ stock in the $50s – don’t.
FINL, FL - Wounded FINL not good for FL
Most of these wounds at FINL were self-inflicted with the supply chain issues causing $0.42 of the $0.45 miss, and costing eight percentage points of revenue. Unlike FL which, has executed exceptionally well since Ken Hicks took the reins in 2009, FINL has had its fair share of hiccups.
But, a wounded FINL is not good for FL. Especially as inventories across the industry remain elevated, and NKE, UA, and AdiBok push direct to consumer agendas. It's a bit tough to make an industry read-through because of the supply chain execution issues, but basketball underperformed running for the 4th straight quarter. If there is a positive for FL, it would be that inventory was down 14% during the quarter, meaning that anybody frustrated by out of stocks at FINL during the month of November could have transferred spending over to the other mall based footwear retailer. Though to be fair, apparel was more affected than footwear. Comps to date at FINL are up 6.2%, as the company gets desperate.
We remain confident that Foot Locker will prove to be one of the best multi-year shorts in retail. The company is likely to earn about $4.20 this year, which we think will prove to be the high water mark in this economic cycle. We think that emerging competition from its top vendor, Nike (=80% of sales), will stifle growth, and leave the company with an earnings annuity somewhere around $3.50-$3.75 per share. Is that worth $61? Not a chance. Not for a company that is Nike’s best off-balance sheet asset. And definitely not when the Street is in the stratosphere approaching $6.00 in EPS (#NoWay).
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