KSS announced it is cutting 250 employees at HQ removing some positions in regional management and refining merchandising teams. 250 salaries at a HQ with thousands of employees, isn’t huge, but that savings is likely ~1% of SG&A, ~4% in EBIT, and roughly $0.25 in earnings opportunity. The savings is a plus, but the signal is clearly a negative. After about a 2 year time period of ‘success’ from early 2017 to early 2019 riding tax reform, a consumer ramp, and better margins from ‘standard to small,’ reality quickly set in in 2019. The Amazon returns initiative has only pressured margins with minimal benefit to traffic, as we forecasted in our Black Book in April. We think reality will further set in in 2020. That reality is that KSS operates in a structurally impaired business with a weak value proposition relative to competition, it is sitting on a powder keg of private label credit exposure, and has no foreseeable way to turn around the long term earnings trend from one of big declines to even small consistent growth. In concert with this layoff announcement, the company hinted at a new growth plan that will most likely be revealed at the company’s investor day in March. KSS will be reorganizing more toward its "ambitious growth agenda” per CEO Michelle Gass. Props to Gass for recognizing the risks and going down swinging. She championed Amazon returns, introduced new brands, and will likely have new initiatives at this event. However we don’t think anything can stop the forces that are pushing retailers like KSS into oblivion, and in going down swinging KSS will ultimately test new lows.
Credit Powder Keg
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 EBIT, 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 assume 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 this as a very real scenario over the tail duration for KSS, we wouldn’t call KSS cheap probably until it is approaching $20, more than 50% below current levels.
2020 Guidance
The guide down on holiday sales was 4th EPS guide down of the full year estimate since the March 4Q18 print set the year at $5.80-$6.15... it's now at the low end of $4.75-$4.95. We think we haven’t seen the last of these downward earnings revisions.
When talking about 2020 on the last call, Gass mentioned continued excitement around the top line (i.e. comp growth) and expecting to get back to margin expansion. We think the former is not easy, but possible. The latter seems very unlikely from where we sit even with the announced job cuts. After an ugly 2019, the new CFO Jill Timm likely doesn’t want to miss a quarter early in her tenure. And looking to 2020, unless Gass forces her hand, she won’t make the same mistake Besanko did last year. Expect a guide down on the 4Q print ahead of the investor day. The good news for KSS is it might have a few quarters of a clearable bar should it appropriately reset expectations. Though we should note, KSS results were not good in 2019 when the consumer was strong and the company had several initiatives aimed at driving traffic. If the consumer weakens materially in 2020, credit exposure and comp deleverage means no guide management can likely fathom will be low enough.
