How a Buyout Gone Bad Can Make for a Better Buy

Over the past six months three separate bidders were vying to take discount retailer Kohl's private. All three groups did extensive research to establish how much above their bids KSS was really worth. Kohl's decided on June 6 to limit negotiations to just Franchise Group, the privately held owner of Vitamin Shoppe, who was then offering $60 per share, putting a value on KSS at $8 billion, according to press reports. Recession fears and talk about weakening retail sales then saw Franchise Group first reduce its bid to $54 per share. Later it pulled away from that, too. Traders who only held KSS for a potential deal, immediately bailed out, driving the stock briefly as low as sub-$27. As of Thursday, KSS had rebounded to north of $30. The panic selling was clearly unrelated to KSS's fundamentals. The firm posted all-time record earnings per share of $7.33 in fiscal 2021, which ended Jan. 29, 2022. That year appears unrepeatable in fiscal 2022, but Value Line still calls for EPS of $5 this year and $5.40 in fiscal 2023. Those are really solid earnings on a $30 stock. Kohl's pays a generous, but well-covered 50 cent quarterly dividend. At $30.13 per share that calculates to a 6.64% current yield. KSS' price-to-earnings hasn't been this low in more than a decade. Its yield is now better than what was available at previous buying opportunities during 2013, 2016 and 2017. Each of those times launched major, very tradable rallies. So did the Covid-panic selling during the spring of 2020. Kohl's typical multiple calculates to 12.3-times, accompanied by around 3.38% in current yield. Simply reverting back to 12-times fiscal 2023's estimate suggests an 18-month target price of about $65 is well within reach. That goal is not far fetched. KSS topped out from $51.30 (in 2020) to $83.30 (in 2018) during each of the years dating all the way back to 2003. Research from Fast Graphs is in full agreement. Based on their own calculations they see KSS as worth north of $66 by next winter and above $82 per share a year later. Independent work from Morningstar is even more bullish on KSS than that. They assign a 5-star, best buy, rating to Kohl's. Morningstar deigns to provide year-ahead goal prices but does let us know they see present-day fair for KSS as $58 right now. That implies almost double the current quote is possible if just that modest target is achieved. Yahoo Finance and others note that KSS fetched $64.38 as recently as Jan. 24 this year. Buying shares outright locks in an excellent income stream plus extensive upside potential. Option traders can also benefit from KSS's great valuation in a couple of other ways as described next. Actual option pricing on near-the-money strike prices out to a Jan. 19, 2024 expiration date, with KSS at $30.09, is shown below. Selling $30, $35 or $40 strike price naked puts seems especially tempting. Here are the if exercised prices on those with their accompanying margin of safety. Where else can you stand to make fine returns with no initial cash outlays (in margin accounts) and still be protected against unexpected declines of from almost 15% to nearly 27%? Maximum profits on these, or any other option sales, always equals keeping 100% of all premium dollars collected up front. On m y examples that would equal $800, $1,080 or $1,440 per 100-share commitment depending on the strike prices employed. Sophisticated option traders could also consider setting up January 2024 $40 Buy/Write combinations as detailed below. If executed in a margin account with excess free buying power and held through expiration day there are just two possible outcomes. KSS will either finish at $40 or higher, as I expect, or below $40. If the former possibility plays out the following best-case scenario will unfold. Any upturn to $40 or better (+32.94% from the trade inception price) translates into a gross profit of over 280% and an annualized gain north of 187%. How cool is that? What if KSS fails to reach and hold $40 upon expiration? If so the worst-case scenario detailed next would take place. You'd end up with a double-sized long position in KSS and need to pony up an additional $4,000 along the way. The good news is that your average net cost would drop to just under $24.15 per share. That means any decline of less than 19.7% from the trade inception price would allow for immediate liquidation without a loss. Any close below $40, but not too far below that, would still provide a very high profit. An exactly unchanged close of $30.09 on Jan. 19, 2024, would generate a $5.94 per share gain times 200-shares, or $11.89 on stock that went absolutely nowhere. Future stock market action can never be guaranteed. The 10-year chart below, though, shows that owning KSS at below $25 would have been a winning position for all but a few months out of the past 120 months. A 95% success rate is about as good as it gets in stock market investing. Even the five or six months when you showed paper losses only occurred in the Covid-panic period which is unlikely to recur. Buy some KSS shares, sell some puts or consider going with full buy/write combinations. I was smart, and lucky, enough to add to my KSS position not long ago below $27.

How a Buyout Gone Bad Can Make for a Better Buy

After a failed bid from the Franchise Group, the lack of a near-term buyout made Kohl's a good play for investors. Let's see how.

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