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Value Idea Contest: Kohl's (KSS)

March 11, 2013 | About:

Chandan Dubey

99 followers
The Kohl's History

Here's a timeline of Kohl's Corp (KSS) evolution:

1962: The first Kohl’s department store was opened in Brookfield, Wis. Its founder Max Kohl had already succeeded in turning a small grocery store into the largest supermarket chain in the Milwaukee area. Max Kohl positioned its department store between the high-end stores and the discounters. He sold everything from shoes and candy to engine oil and sporting gear.

1978: A division of British American Tobacco PLC, purchased an 80% stake and subsequently took control of the entire business. The Kohl family withdrew from the management.

1983: British American Tobacco sold Kohl’s food stores to Great Atlantic and Pacific Tea Company which subsequently closed all the food stores in 2003.

1986: A management-led group of investors formed Kohl’s Corporation and acquired Kohl’s Department Stores consisting of 40 stores and $300 million in annual sales from British American Tobacco.

1992: Kohl’s Corp completed its IPO with 11.1 million shares. Late in 1996 and 2000 the stock split 2-to-1. Meanwhile, it joined S&P in 1998.

2001: Kohl’s went online.

2008 : The current CEO Kevin Mansell took office in August and was also made the chairman in September 2009.

2011: Kohl's paid its first dividend and its e-commerce business exceeded $1 billion in revenue.

The Business

Kohl’s is a U.S. department store chain headquartered in Wis. Its mission statement is: "To be the leading family-focused, value oriented, specialty department store offering quality exclusive and national brand merchandise to the customer in an environment that is convenient, friendly and exciting."g_IuxW0kOzBCu4LaHBkGYogT8VIOfEYI3UWd_NVE
Kohl’s operates 1,134 stores across 49 states. It sells moderately priced apparel, footwear, and accessories for men, women and children. It also sells home products like furniture, pillow, sheets, and cookware. The merchandise mix has been relatively stable.

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Strategy

Kohl’s sells both private and exclusive brands which are “only at Kohl’s” as well as national brands like Nike, Adidas, Lee, Levi’s, Jockey, Van Heusen. Private and exclusive brands contribute a lot more to the gross margin as Kohl’s has significant control over the production, manufacturing and marketing expense of these brands.

Keeping this in mind, Kohl’s has shifted its merchandise gradually towards this section of merchandise. In 2004, Kohl’s carried 25% in Private and Exclusive Brands, but in 2011 it carries 50%.

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Competitive Advantage

Kohl’s operates smaller stores compared to Macy’s (M), JC Penney (JCP) and Dillards (DDS). Also, its sales per square feet is higher than each of the three companies mentioned above. Higher sales coupled with smaller general expenses gives Kohl’s a small competitive advantage.

In 2011 Kohl's advertising cost was 5.1% of the sales.

Real Estate

Kohl’s has been remodelling and expanding the number of stores it operates. Approximately 50% of its stores are either new or have been remodeled in the last five years. Furthermore, 36% of the stores it operates are owned by Kohl’s and the remaining 64% are on lease.

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Margins

Kohl’s has been able to expand and remodel its business, maintain a positive FCF and keep its margins stable.

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Financial Situation

At year-end (Jan 2012) Kohl’s has a very healthy balance sheet with $1.2 billion in cash. It has $2.1 billion in long-term debt at an interest rate of 6%. It has $303 million in interest expense (out of which $183 million is rent expense) which is well covered by operating income of $2.1 billion.

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Management



The CEO and Chairman of Kohl’s in Kevin Mansell. He has 36 years of retail experience and has risen in Kohl’s from Divisional Merchandise Manager in 1982 to CEO in August 2008 and Chairman since September 2009.

The strong generation of FCF from the business has been put to good use by buying back shares and starting a dividend in 2011. The company paid its first dividend in 2011 of $1 per share for the fiscal year. In February 2012, the dividend was hiked 28%.

The company also has a very large buyback program in place. In November 2012, the BoD increased the remaining authorization by $3.2 billion. Over the next three years, the company expects to repurchase its shares in the open market.

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The management measures it performance by RoI, which is defined by earnings before interest, tax, depreciation and amortization, and rent divided by average gross investment. On the other hand, the RoIC is is around 9%. For a retailer, I would say, this is a very good return.

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The company also has a stock-based compensation plan.

As of January 28, 2012, there were 18.5 million shares authorized and 16.1 million shares available for grant under the 2010 Long-Term Compensation Plan. Options and nonvested stock that are surrendered or terminated without issuance of shares are available for future grants. More than half of the stock options are underwater at the current price.



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More than 50% of the shares are held by institutional investors.

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Valuation



At current price of $46.66, Kohl’s has -$0.9 billion in net debt and and $10.6 billion of market cap, for an EV of $11.5 billion.It trades at PE of 10.6 and EV/FCF of 9.5.

Also, notice that the leftover buyback will continue to increase the EPS and drive shareholder value.

Even a reasonable figure of 12 time FCF will land the share price at $63. A 30% discount for margin of safety will lead to buy price of $44.

Risks



Retail is hardly for the faint hearted. Numerous competitors, cut-throat pricing and fluid customers make it a very risky business. Management missteps will be dear for the shareholders.

Failure in the supply chain, inflation in price of raw material which cannot be passed to the customers, failure in effective capital allocation, seasonality of the business, consumer spending habits and many other factors may negatively impact the business.

The e-commerce business has lower margin than the stores and it seems that currently the e-commerce business is gaining revenue at the expense of the store business. This is because the e-commerce business has lower margin merchandise, has shipping costs and the investment to provide the infrastructure to run the e-commerce business take their toll on the margin.

Kohl’s also runs a credit card operation. The proprietary Credit card accounts have been sold to an unrelated third party but Kohl’s shares some of the risks. A failure in extending credit to customers will adversely affect the results.

Additional Disclosure

The data has been taken from Kohl’s fact book, Kohl’s proxy statement 2012, and Kohl’s annual report 2011. Some of the graphs have been made by GuruFocus graphing tool and the data in the table is taken from Morningstar.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 3.1/5 (20 votes)

Comments

Adib Motiwala
Adib Motiwala - 1 year ago
Good write up. One suggestion. The FY 2012 numbers and balance sheet are out (even while the annual report and 10-K is not). I would use those instead of Jan 2012. So, cash is down to $600m and debt is upto $2500m now.

cdubey
Cdubey - 1 year ago
Thanks for the comment. I see that you have bought Kohl's too ! I will have a look.

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