Mr. Market speaking for itself on this KSS print. Not really a hot mess…but definitely a warm one. KSS print actually ‘about in line’ in the grand scheme of things. I was expecting fireworks this qtr, but instead got a box of those little white snappy things you buy for $0.50 in Chinatown. Guide is bullish at face value, but tax benefit now fully included – so operationally only slight positive. Inventory/sales looks about as good as we’ve seen from KSS since the 2015 peak in the stock – until the company subsequently failed to comp. But inventory levels suggest that the comp guide of 0-2% is not a sandbag. And the shift to (dilutive) third party brands as well as ecomm shift make the GM guide not sandbagged in light of better inventory position. Credit being broken out as separate line item – which should finally add transparency to one of the biggest risks to the story – aside from flat-out failing to drive traffic going forward when we anniversary the best retail macro climate we’ve seen since mid-cycle. Note change in comp calculation…co did not highlight this. Management sounded amazingly bullish, which I think is the problem. Guidance looks aggressive, compares get tougher, and confidence is based on the fourth time in 13 years KSS comp matched aggregate US Retail Sales. Michele Gass has a high hurdle in 2018 – a very high one. And yet the market thinks KSS can push $6 in EPS. Even after taxes, I think $5 will be a push (ie below the guide). KSS is setting itself up to miss this year – a meaningful one. Still one of the best shorts in retail, even after today’s sell-off.
Our thesis holds from our Black Book we presented last month. KSS | Donut or Cronut: LINK
--McGough
McLean’s Model Callouts…
Conference Call:
- Management gave no commentary on credit in 4Q, except to say that it will now include a credit revenue line on its P&L in accordance with ASC 606. We’ll see if this is simply a new number that tells us little, or if we get a real revenue and cost trend from the data.
- KSS will be piloting 5-10 store reductions with Aldi as the box, this is bullish, but the problem is the number is 5-10 because that’s about as many KSS stores Aldi would want to cotenant with of those KSS wants to shrink.
- Company now plans to exceed the $250mm guided in cost savings (which is to be reinvested in other areas). Expense management was a very clear theme of the call. At least there was no talk of managing costs by using LED bulbs in the store to save power costs like at FL. Maybe KSS is already there.
- Management highlighted the new customer acquisition growth as up mid-teens. We’re curious to what that really means, is it simply the added shoppers YY was 15% above last year? How many were online vs in stores? Were any added to rewards? Has KSS been adding or losing customers? It's disclosure implies that the credit card customers has declined 5mm from 30mm in 2014 (Analyst Day) to 25mm at 2018 ICR (this signals higher credit portfolio risk too), while Yes2You customers only increased from 29mm in 2015 to 30mm today. This is the type of metric disclosure that creates more questions than answers in our opinion.
Breaking Down Guidance:
- EPS guided ahead of the street by 4% when adjusted for the tax rate.
- This implies yy growth in EPS of mid-single digits adjusting for tax rate.
- 15 cents is coming from a lower D&A expense, and 9 cents from lower interest expense.
Comp guide of 0-2% is essentially in-line, but perhaps not strong enough. It implies a significant run rate slowdown from 4Q (+6.3% comp) and a slowdown vs FY17’s 1.6%. Our math suggests the tax refund benefit for KSS sales could be 1-2 pts alone, suggesting this guide is weak for this new traffic growth story.
- Revenue growth was guided a point lower than comp (attributed to 53rd week).
- Note, the company changed its comp definition in 2017 to remove stores where a 10% change in square footage happens. That’s notable since the company has clearly signaled a desire to shrink stores operationally. That could mean inflated comps as those transformations happen on weak performing stores.
- “In 2017, we changed our comparable sales definition to align with our internal company reporting. Under the new definition, Kohl's store sales are included in comparable sales after the store has been open for 12 full months. On-line sales and sales at remodeled and relocated Kohl's stores are included in comparable sales, unless square footage has changed by more than 10%. The prior definition included sales for stores (including relocated or remodeled stores) which were open during all of the current and prior periods.” -KSS 10-Q
Gross Margin guided +5-10bps
The inventory position is very bullish headed into 1Q, though the compare is tough and the company tempered expectations.
We struggle with how KSS can continue to grow gross margin since:
- Ecommerce will continue to be dilutive,
- Transport costs are accelerating out of regulatory changes in trucking,
- Wal-Mart continues to invest in price competing away its tax benefits,
- KSS is mix shifting to lower margin national brands,
- Higher cotton prices are flowing through the supply chain.
KSS needs low promotions/clearance and high AURs to continue driving GM% higher. We don’t see that as a likely perpetual condition.
SG&A Guided +1-2%
This seems aggressive given:
- The company signaled itself that wages are headed up mid to high single digits.
- It continues to spend in technology, while trying to cut costs elsewhere to offset (likely other corporate),
- Distribution costs continue higher, as noted in gross margin above (these fall in both COGS and SG&A),
- The company needs to invest in marketing/experience to drive top line, we think Gass wants a traffic/growth story,
- Credit is going to continue to be a headwind, portfolio revenue growth has stalled (disclosed by COF), while bad debt costs continue to rise (signaled by COF and M).
Also let’s keep in mind that until this year, KSS had not hit its initial fiscal year guidance for 5 years straight.
