Kohl's Corporation KSS
December 17, 2007 - 4:50pm EST by
widemoat942
2007 2008
Price: 47.31 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 14,840 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Along the lines of the best investment ideas embodying obvious decisions, I’d like to direct your attention to KSS.  What you’ll see is an exceptionally well run company that while susceptible to short term earnings pressure, should over the long run continue growing earnings at a double digit rate while sustaining returns well in excess of its cost of capital.  Trading at 13x this year’s consensus estimate KSS conservatively offers 60% upside with 10-20% downside.

With KSS representing a well known and widely followed company, I will keep my business description short.  With over 900 locations, KSS is a well established off-mall department store with significant growth opportunities.  KSS primarily differentiates itself versus other retailers with a strong collection of national, exclusive, and private brands that combine to deliver a unique combination of value and satisfaction relative to traditional department stores or discount retailers.  As a result, KSS’s has successfully tripled its store count over the last eight years while earning double digit returns on capital despite operating in a mature and saturated market.

Why So Cheap?

Since hitting a high on 4/20/07 KSS has declined more than 40% while the market as a whole has fallen 1.8%.  The reasons are straight forward.

1.       Fear of a consumer slowdown

2.       Lowered 4Q guidance

3.       2008 estimates have been reduced 11%

With the current macro-backdrop, a near term earnings miss is a definite possibility.  However, unless the state of the world has changed so dramatically that the next 5 years look very different than KSS’s recent past this differentiated retailer looks to be building value at a rapid pace.  At the very least, the multiple has contracted from over 20x this year’s earnings to 13x, heavily implying the market is already pricing in a decline in this year’s earnings, and lackluster growth over the next several years.

In trying to place a conservative price target on KSS’s shares, we have looked at a scenario analysis for earnings and multiples over the next several years.  While preferring a free cash flow model, it is roughly guesswork to determine when the business will slow growth investments thus rendering a dcf value lacking a whole lot of confidence.

Kohl’s issued the following long term guidance in October:

  • Total sales increases of 9% - 11% CAGR
  • Comparable store sales increases of 2% - 4% per year
  • Operating Margin of 13% - 13.5% by 2012
  • EPS Growth – CAGR of 15% - 17%
  • Targeting over 1,400 stores by 2012 (8.5% cagr)
  • Mix of prototype (88K sq. ft.) and small (68K sq. ft.) and urban stores (130K sq. ft.)
  • Split by year dependent upon timing of real estate opportunities

Unless you want to bet against KSS’s ability to continue executing along the lines of its recent past, the real question becomes what will earnings look like next year and how long-lasting will the economic headwinds prove to be. 

KSS hits current estimates and grows at the low end of long term guidance range

2007

2008

2009

2010

2011

EPS

3.55

          4.02

          4.62

          5.31

          6.11

yoy growth

7%

13%

15%

15%

15%

Price @

14x

        56.26

        64.70

        74.40

        85.57

16x

        64.30

        73.94

        85.03

        97.79

18x

        72.33

        83.19

        95.66

     110.01

KSS misses 07 and 08 and grows below the low end of long term guidance range

2007

2008

2009

2010

2011

EPS

3.40

          3.47

          3.88

          4.35

          4.87

yoy growth

3%

2%

12%

12%

12%

Price @

14x

        48.55

        54.38

        60.90

        68.21

16x

        55.49

        62.15

        69.60

        77.96

18x

        62.42

        69.91

        78.30

        87.70

Consumer recession and then moderate growth

2007

2008

2009

2010

2011

EPS

3.45

          3.11

          3.42

          3.76

          4.13

yoy growth

4%

-10%

10%

10%

10%

Price @

12x

        37.26

        40.99

        45.08

        49.59

14x

        43.47

        47.82

        52.60

        57.86

16x

        49.68

        54.65

        60.11

        66.12

Things go very poorly

2007

2008

2009

2010

2011

EPS

3.45

          2.93

          2.93

          3.02

          3.11

yoy growth

4%

-15%

0%

3%

3%

Price @

12x

        35.19

        35.19

        36.25

        37.33

14x

        41.06

        41.06

        42.29

        43.56

16x

        46.92

        46.92

        48.33

        49.78

In examining the preceding scenarios it becomes clear that for investors with a longer timeframe the market has priced in a dour outlook for KSS.  While the upside into the mid 70’s is readily apparent if KSS can continue executing and consumer spending falls less than expected, the downside is perhaps even more interesting.  Even in an environment where weak consumer spending results in a -10% comp; continued store build out, share repurchase, and reasonable inventory management should prevent earnings from falling below $3/share.  Even in a scenario where a large negative comp, below average new-store performance, and poor execution resulted in operating margins falling to 9.5% (well below the 11%-plus earned in 2001-2002 period) earnings of $2.60 would mean KSS is trading at a fair 18x trough earnings.  While temporary multiple contraction could result in 20% downside in the near term, the margin of safety inherent the current valuation seems wide. 
Catalysts
  • 2008 earnings are better than feared.
  • Continued rollout of exclusive brands.

Risks

  • Severe and prolonged decline and stagnation in consumer spending.

Catalyst

2008 earnings are better than feared.
Continued rollout of exclusive brands.
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