Takeaway: Despite reports, the KSS story isn’t improving. Paths lead to a dividend cut in 24 months, and cessation of its existence within a decade.

We had 3 people in as many days ask us about our current thinking on KSS. The impetus is that there’s the perception – and it’s partially correct – that inventories are in a position across retail that is forcing/allowing retailers to restock inventory. A rare occurrence unless business trends are generally healthy on the margin. Here’s out TRADE, TREND and TAIL view on KSS.

TAIL: Same call here. 1100 stores should be 700 to sustain returns over the next 5 years – but at a much lower earnings base. Existing box should be 30% smaller. Mgmt won’t do this. Kohl’s likely won’t exist as either a retail banner or a public equity in a decade.  It will be a distant memory for millennials. No take-out play here – no real estate optionality whatsoever. KSS has a lease duration of over 20 years (23 to be exact). That means that management made an egregious bet that the stores will be relevant 20+years down the road in order to secure low rent expense. These liabilities should be half that amount. Due to the pushing out of real estate expenses (this is inarguable), this is a company that needs a 1%-1.5% comp to leverage occupancy. That’s so low bc of aggressive leases. And yet it’s only comped that rate 1 time in four years at the store level. For real?  This is the worst management in the industry, but we’d argue that the story so terminal that it can’t even be fixed by good management.

TREND: I’m always concerned about the volatility by quarter – this is KSS, afterall. We’ve got a back-half EPS miss by 3%, which is not tremendous. Next year, however, Richards is modeling a miss of almost 15%. We’re at $3.39 vs the Street at $4.13. Street is marching well above $5 over next two years. We don’t think it will ever see $4 again. KSS actually put up a respectable (for KSS) 1% in 3Q last year, and 0.4% in 4Q. That 0.4% includes a 30% e-comm comp. Golf clap there. But check out the YY e-comm site rank below. Really abysmal. Decelerating on the margin at a time when overall online retail is accelerating.

TRADE: Stock looking cheapish at 10.6x ’17 consensus. But on our numbers it’s 13x. This thing can trade as low as 8x earnings. That sounds low, but 1) it’s been there before, and b) we’ve got EPS coming down to $3 the following year vs Street at $4.21.  8x our 2017 numbers or 10x a normalized 2018 is closer to $30 vs $44 today. At that level it is at a 14-15% FCF yield. Again, sounds cheap, but a) it’s been above 20% before, and b) this company is likely to cut its dividend at the turn of the eco cycle. FCF yield valuation goes away with a dividend cut.  

KSS | Here’s Where We Stand Today on a Name Unlikey to Exist in 10 Years - 9 12 2016 chart1

KSS | Here’s Where We Stand Today on a Name Unlikey to Exist in 10 Years - 9 14 2016 chart2