Shares of Kohl's (KSS -3.30%) soared in early 2022 on reports that multiple suitors were interested in buying the company at a substantial premium. However, Kohl's stock has tumbled 29% over the past month as investors have grown concerned about the impact of high inflation on the retailer's sales and profitability.
Indeed, Kohl's stock reached a new 52-week low last week following a big earnings miss and guidance cut. Moreover, some bidders appear to have lost interest in buying Kohl's, while others plan to reduce their offers, according to Reuters. That said, investors have overreacted to the recent news, making Kohl's stock a great buy based on its Friday closing price of $41.87.
Sales momentum cools abruptly
Three months ago, Kohl's reported that sales grew 5.8% year over year in the fourth quarter of fiscal 2021, as the department store chain continued to recover from the worst of the COVID-19 pandemic. Management cautioned that growth would slow in early 2022, though, before reaccelerating as the company made more progress on its strategic initiatives over the course of the year.
Unfortunately, sales trends took a sharp turn for the worse in April due to tougher comparisons and the impact of high inflation on discretionary spending. As a result, net sales fell 5.2% year over year in the first quarter of fiscal 2022, even though sales growth had been positive through late March.
The sales slowdown -- combined with rising freight and labor costs and other growth investments -- caused Kohl's adjusted earnings per share (EPS) to plummet to just $0.11 from $1.05 a year earlier. This missed the analyst consensus of $0.70 by a country mile.
Making matters worse, inventory has increased by over $1 billion over the past 12 months. That is weighing on cash flow, and it could potentially lead to further margin pressure later this year, although management says inventory levels remain appropriate.
In light of the weak Q1 results, Kohl's slashed its full-year EPS guidance range to between $6.45 and $6.85 from an initial range of $7 to $7.50. The company also said it expects sales to grow just 0% to 1% for the full year.
Is the business really broken?
The sharp drop in Kohl's profitability last quarter and the guidance cut might make it seem like the company is in deep trouble. Based on the recent plunge in Kohl's stock, it appears many investors have bought into that narrative. Most notably, activist investor Macellum Advisors is urging the company to sell itself at any price and to slash investments in the business until it consummates a deal.
Image source: Kohl's.
This sort of panic is completely unwarranted. For one thing, Kohl's indicated during its earnings call that sales trends have improved significantly in the first few weeks of the second quarter.
Additionally, while Kohl's Q1 results lagged rivals like Macy's, that largely reflects differences in their product assortments. Macy's management noted that sales of active and casual apparel and soft home items slowed dramatically last quarter compared to the fourth quarter of fiscal 2021. Those merchandise categories represent the bulk of Kohl's business, whereas Macy's was able to offset weakness there with strong growth in areas like dressy apparel and luxury items.
The Sephora factor
The ongoing rollout of Sephora beauty shops within 850 Kohl's stores has also impacted recent sales trends. The 200 Kohl's stores that added Sephora boutiques in 2021 posted positive comparable sales last quarter, dramatically outperforming the rest of the chain.
This bodes well for future sales trends as Kohl's rolls out the Sephora shops to the majority of its stores. Indeed, Macy's noted that demand for beauty products is soaring due to mask restrictions being lifted and people returning to offices in greater numbers.
On the flip side, about 400 Kohl's stores have had prime space out of commission in recent months to accommodate construction of the next round of Sephora boutiques. This undoubtedly hurt sales. By August, all 400 new Sephora shops will have opened, tripling the Sephora at Kohl's footprint. That should be a big sales catalyst.
Many Kohl's stores have had Sephora shops under construction recently. Image source: Author.
Many ways to win
If Kohl's decides to sell itself, it will probably have to settle for a price around $60, well below the initial offers, which reached as high as $69. But that would still give investors a big windfall relative to the current stock price.
If the company instead stays public -- which seems more likely -- Kohl's stock could have a bumpy ride in the near term. But Kohl's plans at least $1 billion of share repurchases this year, which will allow it to capitalize on any dips in the stock price.
Moreover, Kohl's stock trades for just 6.5 times the low end of its updated 2022 EPS guidance. That rock-bottom valuation suggests that most investors expect Kohl's results to continue going downhill. However, as Kohl's completes the Sephora rollout and demand normalizes over the next few years, it seems more likely that sales and earnings will reach new highs. This makes Kohl's stock look like a fantastic investment opportunity right now.
