Kohl’s shares are a great buy after profits

Kohl’s (NYSE: KSS) served another big winning beat on Thursday. Although the company has lagged behind many of its peers in terms of revenue growth this year, it has continued an impressive streak of margin expansion.

Investors initially rewarded the company for its strong third-quarter margin performance, pushing Kohl’s stock up more than 10% on Thursday. However, stocks then fell 9% on Friday, losing almost all of those gains. This makes Kohl’s shares an absolute theft for long-term investors.

Kohl share performance, data by YCharts.

Another quarter of stellar profitability

In the second quarter, Kohl’s posted record earnings per share (EPS) of $ 2.48, although revenue barely increased from the same period two years ago. An exceptionally strong gross margin and tight expense control allowed the company to post its highest second quarter operating margin in a decade.

Similar trends emerged in the third quarter. Net sales increased 15.5% year-on-year to $ 4.37 billion, but only increased 0.2% from the third quarter of 2019. Total revenue actually declined slightly over the course of the year. of this period, due to the decline in credit card revenues (which are excluded from net sales).

For the second consecutive quarter, supply chain challenges weighed on sales. Kohl’s ended the period with inventories down 25% from two years earlier. Additionally, a higher than normal proportion of this stock is still in transit (i.e. not available for sale) due to delays in ports and other supply chain constraints. Management said inventory is particularly tight in the women’s clothing category, which typically accounts for at least 25% of sales.

The exterior of a Kohl stock.

Image source: Kohl’s.

On the other hand, Kohl’s took advantage of the combination of high demand and tight inventory by reducing discounts. Gross margin reached 39.9% – from 36.3% two years earlier – despite higher freight costs. At the same time, operating expenses decreased slightly from the third quarter of 2019. As a result, adjusted EPS more than doubled from $ 0.74 two years ago to $ 1.65 last quarter. This crushed the average analyst estimate of $ 0.64.

The outlook for the full year is improving again

Following its latest earnings, Kohl’s raised its full-year adjusted EPS forecast by over $ 1 to a new range of $ 7.10 to $ 7.30. In early 2021, he estimated full-year EPS would be between $ 2.45 and $ 2.95.

Kohl’s has a good chance of beating this updated prospect. While consumer discretionary retailers typically post their highest margins in the fourth quarter, Kohl’s guidance for the full year implies a sequential decline in margins this quarter. High freight costs and sky-high vacation shipping surcharges are significant headwinds, but management seems to have left a lot of room for error in its guidance.

Acceleration of buyback activity

Kohl’s shares are currently trading for just eight times the company’s forecast Adjusted EPS for 2021. Additionally, the company has a strong balance sheet and generated $ 1 billion in free cash flow in fiscal 2020 ( despite the pandemic) plus an additional $ 1.3 billion in the first nine months of fiscal 2021.

KSS Free (Yearly) Cash Flow Chart

Kohl Free Cash Flow (YoY), given by YCharts.

As the company’s performance improved – while its share price languished – Kohl’s stepped up its share buyback program. After repurchasing just $ 46 million of Kohl stock in the first quarter, the company spent $ 255 million on buybacks in the second quarter and $ 506 million in the last quarter. In the first nine months of the year, it repurchased around 10% of its outstanding shares.

Despite its aggressive buyout activity, Kohl’s ended the last quarter with nearly $ 1.9 billion in cash. As a result, it plans to repurchase an additional $ 500 million of shares in the fourth quarter (approximately). With its strong cash generation, Kohl’s could continue to repurchase around $ 1 billion of shares per year over the next several years, leading to further reductions in the number of shares.

Kohl’s stock will skyrocket

Strong consumer demand and an unusually docile promotional environment have undoubtedly boosted Kohl’s profitability this year. Nonetheless, the company is well positioned to further increase its profits in the years to come.

First, improving inventory levels – especially for women’s clothing – will allow Kohl’s to achieve sales it currently lacks. Second, Kohl’s groundbreaking partnership with Sephora is just beginning. The retailer opened its first batch of 200 Sephora stores in its stores last quarter – with early results exceeding expectations – but it will increase that number to at least 850 by 2023. Third, Kohl’s continues to improve its portfolio of brands, adding Calvin Klein, Tommy Hilfiger and Eddie Bauer to its merchandise mix in recent months.

If Kohl’s can capitalize on these favorable winds to accelerate sales growth while keeping its profit margin close to current levels and aggressively buying back stocks, EPS could easily reach $ 10 within a few years. This makes Kohl’s stock a great deal today.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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