In 2021, Kohl's Corp. (KSS) will have its best earnings year on record by far, and activists have been circling the company for months. Yet the stock is struggling after recovering from pandemic lows. Wall Street anticipates the retail profit comeback won't last, presenting a buying opportunity.
In April, a group of activist investors with close to a 10% stake in Kohl's agreed to place two new directors on the board. Last week, another activist fund, Engine Capital, pushed for Kohl's to sell the company outright or split off its e-commerce division. This strategy models Jana Capital's push for Macy's (M) to split off its e-commerce business and follows Saks Fifth Avenue's plans to take its e-commerce unit public via an initial public offering, potentially at a premium valuation.
Kohl's business is in the midst of a record performance as the stock trades at a historically low price-to-earnings (P/E) multiple of around 6.5. Last quarter, the company blew away analyst expectations with earnings of $1.65 a share, more than double street estimates of 70 cents, plus issued strong fourth-quarter guidance. After a significant earnings pop, the stock has fallen more than 20%.
Whether activist investors unlock value in the stock through various business break-up options or not, the shares are undervalued and investors can buy in at these levels. The risk/reward skews significantly toward positive returns.
Kohl's market cap is a modest $6.7 billion compared to the $1.2 billion share buyback expected to be completed this year. Indeed, the stock has traded flat over the last 20 years while buybacks have cut shares outstanding from 338 million to 147 million, a reduction of 56.5%. With another year of solid cash flow expected, Kohl's could continue to reduce the share count by 20%. Eventually, this massive share reduction will have an impact.
Wall Street analysts are understandably torn as many retailers have staged remarkable comebacks. In most cases, the recent market action has taken a cautious approach by maintaining historically low price to earnings in many retail stocks, assuming the sustainability in business trends can't continue. Retail blowups in Nordstrom (JWN) and The Gap (GPS) add to skittishness for the group. While it's hard to argue that the business rebound with its breakneck same-store sales increases and solid margins will continue and comparisons may prove difficult, the low valuations more than discount a normalization in several retailers, including Kohl's.
In Kohl's favor, off-mall retailers have demonstrated far more resilience than mall-based ones. Plus, Kohl's is not merely a beneficiary of the general in-store turnaround. The company is also attempting to enhance the shopper experience with Sephora in-store shops. The plan is for Sephora to roll out in 800 stores by 2023, approximately 75% of current Kohl's locations. Sephora has also been well-integrated into Kohl's online experience. Analysts are optimistic about the move; Jefferies remarked in its assessment, "The store experience was far more grand than the renderings portended; this is a proper Sephora experience in Kohl's." Jefferies has already noted a positive sales impact, outperforming initial expectations even as Sephora is currently in fewer than 20% of locations. Jefferies has a $75 price target anticipating a reasonable 5.5x enterprise value/EBITDA.
As part of its effort to broaden reach, Kohl's has reported a significant increase in customers, especially millennials, visiting stores due to the Amazon (AMZN) return service. In addition, Gordon Haskett's analyst published survey results that show Kohl's maintaining strong results this holiday season; he has an $85 price target.
With an attractive stock valuation plus activists pushing for an investor-friendly transaction and the in-store addition of Sephora further improving sales trends, Kohl's shareholders will likely be well-rewarded in the coming year.
