The quarter was a disaster. Retail sales down 40%, retail gross margin down nearly 2000bps with inventory write downs, SG&A only down 16% with management noting about 3pts of Covid procedure costs, big earnings loss for the quarter. The bright spot is cashflow from ops only down 61% as the company deferred rent payments and extended vendor payment terms.
Store Performance
What matters now is the future. Stores are opening up and the company noted that stores are seeing comp rates at down 40%-50%, though e-commerce is apparently not being negatively impact at least, in those open store markets. You can't run a retail store profitably with comp rates down anywhere near this much, so we’ll need to see much better traffic trends before the P&L inflects to profits at KSS.
Credit
Credit income is likely the biggest risk vs expectations for a multi-year time period. Credit (other revenue) was up slightly in 1Q. We expected minimal change as April COF card metrics indicated the delinquencies were not changed much yet given forbearance actions, so we won’t see a credit impact until 2Q numbers. So the P&L looks this bad with credit being UP YY.
The street is expecting a 25% decline in other revenue in 2Q, then a mid to high SD decline in 2H. The company mentioned that it expects credit to be down due to the reduction in sales, but what management is leaving out is the shared risk with COF in terms of defaults in the credit portfolio.
We think the impact will be much greater than the street is forecasting. We are modeling $400mm in lost revenue from credit in 2020, but the downside could be even worse than that (we outlined this in our Retail Credit Card Black Book with our Financials team in early April, Link Below). So as the street is expecting the model to rapidly improve, we think there is another big profit hit in the coming quarters from credit risk.
When we look out longer term, retail will recover to a degree, but will never see the same revenue and EBIT levels due to lost customers and a mix shift to lower profitability ecommerce. Long term credit recovery we think will come well short of the levels seen in 2019, as income growth has come from lending more to the same customers and rising late fees. The card customer count has been shrinking since 2014, and given KSS’s struggle to add a younger consumers to its base, the card portfolio is unlikely to fully recover after expected heavy charge-offs from Covid-19.
KSS remains a Best Idea Short and if we’re right on the credit angle, we think there is downside to a stock in the high single digits.
Retail Credit Powder Keg Black Book Link: CLICK HERE
