KSS reports Tuesday before the open. We’re a couple pennies ahead of consensus on this print, and we expect some rate of change improvement. For those reasons, we wouldn’t be pressing into the event. We see 4Q bar as high, and 2020 numbers off by ~15%. Stock is back around 11x EPS and short interest is at 11% down from ~20% 6 months ago. Short more on any strength seen around this event into another downward revisions cycle in 2020.
Amazon Returns
The Amazon returns program went nationwide in July. KSS downplayed the impact that it had on the comp acceleration seen intra-quarter in 2Q. Though at the same time the company is implying some aid to traffic.
Our store checks indicate that the return service is clearly being used.
CEO Michelle Gass was noted in an interview to have said that “80% of customers returning Amazon items shopped in the store after the initial transaction.” The key missing information is are those incremental shoppers, or just people that were going to be in the store anyway. Then since anyone returning Amazon items gets a 25% off coupon for the store, do those 80% then only shop because they got a nice discount.
So the real question the company will have to answer this quarter is are Amazon returns driving incremental sales, and if so, is there real incremental margin dollars coming from those sales. Especially when you consider that the higher the adoption and use of Amazon returns, the greater the SG&A costs needed to facilitate the service.
For more detail see our black book on the Amazon return program KSS Sleeping With the Enemy, Link: CLICK HERE
Exec Departures
We have to flag the departure of two top executives at KSS. Both President & COO Sona Chawla and CFO Bruce Besanko announced departures from the company just about a month apart. Chawla's reported to be for “other opportunities”; Besanko's reason was heading to retirement stepping down as of November 1. Regardless of the reasoning, it certainly does not look bullish for the company to lose 2 top execs months after reporting its first truly bad quarter in a year and a half.
Kitchen Sink on 2H, Yet Only Amazon Matters
There are a lot of initiatives hitting in 2H. Amazon returns, Nine West, Elizabeth and James, expanded Active, expanded Adidas shops, Jason Woo collection, Curated by Kohl's… we’re probably missing something there too. With all of those coming, the company is guiding to positive 2H comps. We commend management for trying some unique ideas, but what happens to investor confidence if the company can’t comp even with all of those traffic/comp drivers, and margin pressure from investments that should aid sales growth? Ultimately we think the only piece that matters is can Amazon really drive accretive traffic. These initiatives might get bulls excited, but it’s not a lasting solution to the greater structural headwinds KSS sees.
Standard to Small Done
Gross margins for KSS had been bucking the secular pressures seen by other retailers, but not anymore. We think the biggest driver of previous margin strength was KSS’s ‘standard to small’ initiative, which should see notable diminishing returns as the company hit its 500 store target by end of 2Q last year. KSS is flagging ecommerce dilution on margins, that won’t be going away for a long time. Inventories remain high, so expect some continued merch margin pressure.
Actual Comparison Set-up/Weather
A reminder that there are 2 sets of comps last year given the 53rd week. The true underlying comp trend and comparison set up is below. Also, given the change in weather we have seen over the last couple weeks expect some positive commentary on trend through the quarter and November to date. KSS is one of the more weather sensitive retailers. We think that with Amazon help there could be an acceleration in (and even positive) comp this Q, but that will be given back on margin still resulting in EBIT declines.
Credit / Earnings Risk
We’ve been tooting this horn for a while, but KSS has significant consumer credit exposure. With credit revenue at about 80% of EBIT, net credit EBIT (after associated SG&A) is likely in the area of 40% of company total, or ~50% of EPS. 60% of sales are through the private label card, that means comp risk in addition to the lost revenue/EBIT from the credit card portfolio, while retail gross margins are weakening. If we are at a consumer peak, and we start to see rising delinquencies, the EPS for KSS could decline very rapidly. In a consumer credit rollover (likely in concert with a recession) We think we can easily see 40-60% EPS declines. Given we see that as a very real scenario over the tail duration for KSS, we wouldn’t call KSS cheap probably until it is approaching $20, over 50% below current levels.
