Joe Raedle
Elevator Pitch
I have a Hold rating assigned to Kohl’s Corporation (NYSE:KSS).
I determined that it wasn’t “a good time to buy the company’s shares during the dip” in my earlier article for KSS published on May 31, 2022. In the last four months, or since following my previous update, Kohl’s Corporation’s shares have fallen by -33.5% as compared to a -8.8% pull-back for the S&P 500.
My latest article touches on the recent developments for Kohl’s Corporation. Investors’ attention is drawn to an activist investor’s push for a new management team for KSS, and the company’s future corporate actions with respect to potential asset monetization and tweaks to its existing capital allocation priorities.
My Hold rating for KSS remains unchanged. I have doubts about whether the potential catalysts for Kohl’s Corporation will actually materialize, as these changes are dependent on the intentions of the company’s Board and management. As such, I prefer to adopt a “wait-and-see” attitude for now, which explains why I have assigned a Hold rating for Kohl’s Corporation.
Activist Investor Is Calling For A Change In Kohl’s Corporation’s Management
Seeking Alpha News reported on September 22, 2022 that “activist investor Ancora Holdings” is pushing for Kohl’s Corporation “to replace CEO Michelle Gass and board Chairman Peter Boneparth.”
Specifically, Ancora highlighted “management’s poor execution, as evidenced by the Company’s numbers” in its letter to the Board. One specific metric tells the story of how KSS’ financial performance has deteriorated throughout the year. The mid-point of the company’s normalized earnings per share or EPS guidance for full-year fiscal 2022 (YE January 31, 2023) has been cut from $7.25 in March and $6.65 in May to $3.00 in August as indicated in its Q2 FY 2022 earnings press release. This suggests that Kohl’s Corporation’s normalized EPS is expected to fall by -59% as compared to its FY 2021 bottom line of $7.33 per share.
KSS’ management comments at the company’s most recent investor conference also don’t give investors a whole lot of confidence that there will be a swift recovery for Kohl’s Corporation next year. At the Goldman Sachs’ (GS) Global Retailing Conference on September 7, 2022, the company was asked about its “outlook for potential improvement into 2023.” Kohl’s Corporation didn’t address the question on 2023 prospects directly. But KSS noted that “the softness that we see with the customer demand” will persist in the second half of 2022, and it also highlighted that it anticipates “pressure on margins” as a result of “being more promotional” in the near term.
As such, it won’t come as a surprise that KSS’ shares are down by -44.3% in 2022 year-to-date, which is far worse than the S&P 500’s -21.1% decline in the same time frame.
In Ancora’s letter referred to earlier, the activist investor specifically mentioned that KSS needs new management who “possess operating expertise and turnaround pedigree.” This appears to be a reasonably fair suggestion, as a different set of skills is required for business turnarounds.
At this point, it is uncertain if KSS’ Board will accede to the activist investor’s request, and whether the newly appointed CEO or Chairman will be someone capable of turning things around at the company. Nevertheless, a change in KSS’ management team might be the major catalyst that investors are watching out for, since it will take time for Kohl’s Corporation to see a recovery in its revenue and earnings against the backdrop of a challenging macroeconomic environment.
For the remainder of the article, I will focus on other potential re-rating catalysts for Kohl’s Corporation.
Potential Asset Sales In The Limelight
A September 2, 2022, Seeking Alpha News article noted that “private equity firm Oak Street Real Estate made an offer to buy as much as $2 billion of property” from KSS. If this deal materializes, it will be a significant one, taking into account Kohl’s Corporation’s current market capitalization of approximately $3 billion and book value of equity of around $4.5 billion.
Notably, KSS’ CFO Jill Timm emphasized at the early-September 2022 GS Global Retailing Conference that “I always want to make sure that I’m evaluating opportunities in the market,” when questioned about the company’s “real estate management.” Specifically, Jill Timm disclosed that Kohl’s Corporation is “running a competitive process” to assess if “an opportunity to do a sale leaseback on a portion of our assets” is available.
Asset sales are a key catalyst for Kohl’s Corporation because of the stock’s current valuations.
KSS currently trades at -22% discount to the book value of its net assets based on financial data sourced from S&P Capital IQ. Activist investor Ancora’s own calculations and estimates point to the same conclusion. In its letter to the company’s Board, Ancora noted that “Kohl’s has begun to trade at a steep discount to its liquidation value.”
Therefore, the monetization of KSS’ physical real estate in one way or another will help to unlock the value of the company’s assets. This especially true in this case where the stock is trading below its accounting book value and liquidation value estimated by the activist.
All Eyes Are On Capital Allocation
It isn’t just Kohl’s Corporation’s financial performance that is a concern. The company’s capital allocation priorities and policies are also something that investors are monitoring closely.
As per the company’s Q2 FY 2022 financial results media release, KSS announced a “$500 million accelerated share repurchase agreement.” While share buybacks are typically seen to be good capital allocation moves when a company’s share price have corrected substantially, the general rule doesn’t apply in all cases.
Specifically, share repurchases don’t seem to be the optimal capital allocation move for a capital-constrained company like Kohl’s Corporation. Free cash flow for KSS was negative in the first half of FY 2022, and the company had a modest cash balance of $222 million on its books as of July 30, 2022.
A September 20, 2022 Seeking Alpha News article mentioned that “Moody’s Corporation placed its Baa2 senior unsecured rating on review for downgrade.” Notably, “the $500M accelerated share repurchase program being pursued by the retailer despite cash flow problems” was one of the factors that the ratings agency considered in making this latest decision.
I am certain many investors and credit rating agencies would have preferred that KSS allocate more capital to deleveraging rather than buybacks. It will be reasonable to assume that Kohl’s Corporation’s shares will be in a position to trade higher, if the market had greater confidence in the company’s capital allocation approach.
Bottom Line
Kohl’s Corporation stays as a Hold-rated stock. KSS’ shares have dropped a fair bit since my earlier article, but it is too early to call the stock a Buy. There are potential catalysts in place for Kohl’s Corporation, but there is significant uncertainty over the likelihood and timing of these catalysts being realized. As such, I retain my Hold rating for KSS.
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