Kohl stock: valued at $ 75 without financial engineering (NYSE: KSS)

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After an exceptional quarter with booming activity, Kohl’s (KSS) faces activists eager to dismantle the company. The omnichannel retailer faces the same pressure as other department stores to separate e-commerce activity into what amounts to financial engineering. My investment thesis remains very optimistic about the retailer as the company reinvents the shopping experience.

Financial engineering

Engine Capital Activist sent a letter to Kohl’s pressure to have the company sell the business to private equity firms for at least $ 75, or part with the e-commerce business to unleash shareholder value. Activists made the same claim with Macy’s (M) after Saks Fifth Avenue plans to part ways with e-commerce business at a much higher valuation.

Engine Capital estimated that e-commerce generates up to $ 6.2 billion in digital sales and would achieve a valuation of $ 12.4 billion based on a sales multiple of just 2 times. Currently, Kohl’s is worth around $ 7.5 billion with a valuation that justifies the stock already trading at $ 75.

In FQ3’21, the digital business only increased its sales by 6%, with consumers returning to stores to shop in person. The retailer increased its digital sales by 33% on a 2-year basis, with e-commerce now accounting for 29% of total sales.

The impetus for Kohl’s and Macy’s to part ways with the e-commerce business was speculation that Saks’ digital business would go public via an IPO with a valuation of $ 6 billion. The company has annual revenue of around $ 1 billion and online units were much more attractive a few months ago until growth rates recently normalized.

Unfortunately, online businesses have an advantage over other pure online retailers by having physical locations for quick pickup and returns. The whole omnichannel approach fully implemented during covid shutdowns is what made these ecommerce units much more valuable. A big question arises as to whether the online versions of department stores will be seen as genuinely attractive by the stock market when these operations no longer have the COVID-19 boost by early 2022.

Stick to the game plan

The best option for Kohl’s is to continue with the current plan. The retailer has already rolled out 200 Sephora stores inside Kohl’s while constantly launching new brands offered in department stores to provide fresher merchandise. Sephora stores are already generating an increase in single-digit sales across the store, with 25% new shoppers at Kohl’s.

The department store just released a quarter where EPS more than doubled analysts’ estimates to $ 1.65 per share. In addition, Kohl’s forecasts an operating margin for the year at 8.4% and expected EPS of $ 7.20 per share in 2021, while facing headwinds at inventory levels limiting the rise in FQ4. ’21.

Analysts aren’t overly optimistic that Kohl’s earnings levels will increase, but the general consensus is that the retailer will earn $ 7 per share going forward. The current EPS target for 2023 is $ 7.30.

KSS stock chart

Where the story gets additional interest is the share buyback plan due to the department store currently making up to $ 1 billion in profit as the stock trades at a valuation if skinny. The current share buyback plan can reduce the diluted share count by more than 15% this year alone.

Previous share buybacks were not very effective given that Kohl’s had not previously addressed the company’s structural issues. Current buyout expenses are above previous levels due to higher cash flow generated by the business and the current cash balance of $ 1.9 billion. Kohl’s plans to spend an astounding $ 1.3 billion on share buybacks this year after spending $ 506 million during FQ3’21 and $ 807 million year-to-date.

KSS share buybacks

The company will repurchase approximately 10 million shares at the current share price. The number of stocks will drop below 135 million as FY22 enters, offering huge EPS next year, while some of the headwinds in stocks provide another opportunity for Kohl’s to beat the FY21 BPA target. of $ 7.20.

Unless the activist suggests that separating the ecommerce business creates a better experience for customers, this move makes absolutely no sense. If Kohl’s continues to execute and buy large chunks of stocks, the market will ultimately reward the stock with much higher valuations.

The biggest risk for department stores like Kohl’s is to maintain these higher levels of sales and profits. The company was once happy with EPS estimates of around $ 5. These higher EPS levels are not guaranteed as higher promotions could return with more normalized inventory levels and inflation could put pressure on costs.

If our theory holds up instead, Kohl’s can rally to $ 75 just based on trading just above 10 times the consensus EPS estimate. If the company can actually increase sales through improved merchandise and increased Sephora, the stock could actually have a lot more potential.

To take with

The main investor to remember is that the separation of the ecommerce unit is a short term solution to a problem that does not exist. The department store has already addressed the margin issue and is moving forward aggressively with a new store format and merchandise refreshments.

As Engine Capital points out, Kohl’s is trading absurdly cheap at 7x BPA targets. Investors are expected to continue buying the shares alongside the company at this steep discount and let the management team fully implement the new store plan over the next two years.

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