A solid quarter for KSS, but the market was clearly expecting more. Sales were not what the buy side expected, and in the context of apparel trends at TGT, TJX, WMT, etc, KSS is losing share/customers. The question is will it return? Guidance appears soft, perhaps just some conservatism but can’t hold this multiple tempering expectations. We’re at $4.75 for the year with sales up low 20s vs the current mid to high teens guide. In 2022 & 2023 we see some sales growth but think margins will be going down. Management is already signaling risk on the wage side, particularly focused within DCs, but as we see full reopening and restaffing of stores, we think that wage pressure will be migrating to stores as well. KSS remains well below other national retailers like TGT in starting wage where local laws allow lower minimums. Additionally management is signaling incremental investments, concentrated in 2Q, for the first Sephora buildouts. Extra costs plus sales risk from construction/disruption around summer and back to school shopping to execute Sephora. The expectation is that Sephora will be a home run, and we expect it to drive some incremental earnings, but there is no guarantee that the sales opportunity will justify the costs in SG&A and Capex to implement the shops. Amazon did not appear to drive sales to justify the cost, it’s very possible Sephora could end up the same way. Even if Sephora draws in a new customer, we suspect it will be one that shops more online and does not use a Kohls card, meaning less profit per acquired customer. Longer term the real debate will likely be around whether the company can get gross margins higher. We think gross margins will likely peak out this year given the lean inventories and ramping, stimulus juiced demand. We’ve got gross margins reverting lower given the return of markdown and more price competition as well as the permanently higher ecommerce penetration. Lastly, there is little clarity on credit income. LTM credit revenue is now down over $200mm vs 2019 levels. That is most likely driven by strong pay rates, lower late fees, lower balances on cards. If we think back, KSS had said credit should grow with sales, but then revised that down last quarter. The question now is will credit income ever recover? We should see some normalization with consumers tapping into debt more in the coming quarters, and perhaps some late fees returning. But consumers might never build up to the same balance levels, especially since rewards are available without the card use. Hard to say exactly how it plays out, but for now it looks like a risk for returning to precovid EBIT levels on a multiyear basis. On the positive side for KSS stock is share repo and the return of the dividend. The company bought back $46mm in stock in 1Q at an average price around $58.50, it plans $200-$300mm in repo for 2021.
We remain bearish on KSS as we continue to think its wallet share/spending opportunity is a weaker tailwind compared to other apparel focused retailers due to where it’s taking its category merchandising. Home is now about 25% of the mix, Active is 20%+, and other comfy basic apparel items are probably another 10%. All of these categories were in demand during the pandemic. So less than half the assortment will have the reopening consumption tailwind of people buying the apparel items they avoided for over a year. That means lower relative sales performance, and less relative merch margin opportunity vs many other B&M apparel retailers. Longer term we think cost pressures of wages and ecommerce combined with continued risk of share loss will mean earnings declines and lease inflexibility alongside exposure to the credit cycle mean multiple pressure for KSS.
