Kohl's Stock: Buy, Sell, or Hold?

Kohl's (KSS -3.50%) stock jumped 8% on May 24 after it posted its latest earnings report. For the fiscal first quarter of 2023, which ended on April 29, the department store chain's revenue declined 4% year over year to $3.57 billion but still beat analysts' estimates by $200 million. Its net income stayed roughly flat at $14 million, or $0.13 per share, but also comfortably cleared the consensus forecast by $0.54.

Kohl's growth rates seem anemic, but they cleared Wall Street's low bar and indicated it wasn't doomed to become the next Bed Bath & Beyond. But does that earnings beat make Kohl's a worthwhile turnaround play?

Image source: Kohl's.

What happened to Kohl's?

Kohl's was once considered a survivor of the retail apocalypse, which wiped out many of its brick-and-mortar peers. It survived because its stand-alone stores weren't tethered to dying malls. It rotated its products quickly, controlled its inventory levels tightly, and kept its stores well organized with simple "racetrack" floor plans.

But over the past few years, Kohl's gradually succumbed to intense competition from Amazon, superstores like Walmart and Target, and fast fashion apparel retailers like H&M. Its revenue fell 1% in fiscal 2019 (which ended in February 2020), even as it tried to lure customers back by processing Amazon's returns and leasing out its extra floor space to Planet Fitness' gyms and Aldi's supermarkets.

Those challenges set it up for a rough slowdown during the pandemic's height. In fiscal 2020, its revenue plunged 20% as it temporarily shut down its brick-and-mortar stores. Its revenue rose 21% in fiscal 2021 as it reopened its stores, but that recovery was cut short by inflationary headwinds over the past year. In fiscal 2022, its revenue declined 7%, its inventories rose 4%, and its gross margin declined 485 basis points to 33.2%.

Are brighter days ahead for Kohl's?

Those numbers were ugly, but you can see some signs of improvement by breaking down Kohl's growth in revenue, inventories, and gross margin on a quarterly basis over the past year.

Data source: Kohl's. YOY = Year over year.

This table tells us three things. First, its revenue is still dropping, but those declines are getting milder. For the full year, it expects its revenue to dip 2% to 4% (with a 53rd week in fiscal 2023 adding a percentage point to those estimates).

Second, it resolved its inventory issues, which were caused by supply chain issues and slower consumer spending, by the end of fiscal 2022. Last but not least, its gross margin expanded sequentially and year over year in the first quarter as its inventories declined -- which indicates it isn't relying too much on margin-crushing markdowns to reduce its inventories.

Kohl's expects its gross margin to rise from 33.2% in fiscal 2022 to 36% to 36.5% in fiscal 2023, and for its operating margin to rise from 1.4% to about 4%. It also expects to turn profitable again for the full year with an adjusted earnings per share (EPS) of $2.10 to $2.70 per share. It mainly attributes those bottom-line improvements to lower freight and shipping costs.

But can Kohl's reignite its revenue growth?

Kohl's declining inventories and rising margin suggest its business is stabilizing, but it still hasn't figured out how to grow its revenue again. It expects the expansion of its store-in-store partnership with LVMH's Sephora, which started in late 2020, to drive more customers back to its brick-and-mortar stores -- but investors should recall that J.C. Penney struck a similar partnership with Sephora before collapsing.

Kohl's also plans to gradually replace its general promotions and online-only discounts with "targeted" clearance sales to periodically clear out its unsold products. It believes those shorter clearance sales will drive more shoppers back to its stores without squeezing its gross margin in the same manner as perpetual promotions.

To differentiate itself from other similar retailers, Kohl's will test out more private label apparel and home brands this year. However, most of Kohl's competitors -- including Amazon, Walmart, and Target -- already sell plenty of private-label goods.

Is it time to buy, sell, or hold Kohl's stock?

At $21 per share, Kohl's trades at a mere 9 times the midpoint of its projected earnings this year. That makes it a lot cheaper than Walmart or Target, which trade at 25 and 18 times forward earnings, respectively. Kohl's hefty forward yield of 9.7% -- which would only account for 83% of the midpoint of its anticipated EPS this year -- looks sustainable and is much higher than Walmart's forward yield of 1.5% and Target's forward yield of 2.9%.

That low valuation and high yield could limit Kohl's downside potential, but I wouldn't touch its stock until its revenue growth accelerates again. Investors who already own it should simply hold it instead of selling it at these levels, but it's not a worthwhile buy when other brick-and-mortar retailers are generating more stable sales growth.