Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

The Death Spiral

Can Kohl’s survive the Holidays?

Investors seem to be in serious denial about a number of retail stocks lately, including low-end department store Kohl’s (NYSE: KSS).

Over the course of 2016, Kohl’s has experienced a pretty sharp drop in revenues. It started the year with $19.20 billion in revenues in January that fell to $18.87 billion by October. That made for a revenue loss of $330 million in nine months, not as great as that at Sears (NASDAQ: SHLD) or Target (NYSE: TGT) but still worrisome.

Yet during the same time period, Kohl’s stock went from $49.08 a share on February 1 to $549.44on December 30, 2016. Strangely enough it spiked on December 9, to $59.43 a share.

This seems to indicate that many investors might be making the mistake of reading only part of the financial reports. They saw Kohl’s 4.05% dividend yield on December 30, 2016, and the 11.27% return on equity and 3.37% profit margin for the third quarter but did not notice the rather drastic decline in revenue.

Should Investors be worried about Kohl’s Revenue Collapse?

This brings us to the important question of who is right about Kohl’s, bears worried about the revenues; or bulls who only see the 50¢ dividend paid on December 5? Something investors need to remember is that both bulls and bears are animals with notoriously bad eyesight.

My instinct tells me that the bears are probably right. I just cannot see how the dividends can be sustained with the revenues falling off dramatically. Something that should concern investors was the sudden drop off in revenue throughout 2016.

Another is the bothersome trend of falling revenues during the holiday season. A number of retailers; including Macy’s (NYSE: M) and Target, Kohl’s saw their revenues fall during last year’s holiday season.

Kohl’s was able to buck this trend last year, it went into the holiday season with $19.15 billion in revenues on October 31, 2015, and finished it with $19.20 billion in revenues in January. That made for a modest increase of $50 million, which quickly fell off in first quarter 2016. By April 2016, revenue had fallen to $19.05 billion meaning all the gains from the holidays vanished in three months.

So yes investors you should be worried about Kohl’s revenue drop off. A major concern is the revenue’s effect on net income, which we will examine next.

Is Kohl’s Making Money?

Kohl’s dividend might be threatened because its net income is falling. Back in October 2015 that net income was $746 million, by October 31, 2016 that number had fallen to $599 million. Kohl’s income fell by $147 million over the course of a year.

Disturbingly the fall in revenues has been going for some time back in October 2012, Kohl’s reported a net income of $1.056 billion; that dropped to $932 million in October 2013, and $833 million in October 2014. Kohl’s income has shrunk by around 40% in just four years, which indicates an unsustainable business model.

Although there is one figure that seems to counter that argument: cash from operations. Kohl’s cash from operations has grown impressively over the past year rising from $1.501 billion in October 2015 to $2.347 billion in October 2016. This indicates Kohl’s is making money from its stores.

Those numbers give Kohl’s some float it reported $14.08 billion in assets and $597 million in cash and short-term investments at the end of third quarter. So it might have the resources to survive a changing retail environment.

Will the Holidays Sink Kohl’s Share Price?

All it would take to sink Kohl’s share price is a lousy holiday season which seems to be shaping up right now. Shopper Track reported that retail foot traffic between Black Friday and December 3, 2016, has dropped every year since 2011.

The latest chart from Shopper Track indicates that retail foot traffic this year is about a third less than it was in 2011. Americans are shopping less and buying more online around 18% of the purchases on Black Friday 2016 were made via ecommerce.

What’s truly disturbing is that retail foot traffic fell dramatically, by around 7% between December 11 and December 17, 2016. Shopper Track blamed this on the weather but the Amazon (NASDAQ: AMZN) factor is also to blame here.

Why risk your neck driving to the shopping center in the ice and cold, then freeze trying to cross the parking lot; when you can stay home and do all the shopping on the couch next to the radiator? Then let UPS, FedEx or the USPS  do the driving.

One major worry for Kohl’s and competitors like JC Penney (NYSE: JCP) is will all those shoppers who went online this year because of winter weather come back? Recent history seems to indicate that they will not; which is good news for Amazon, and bad news for department stores.

Department stores like Kohl’s are particularly vulnerable to Amazon, because almost they sell is also sold through the Everything Store. Amazon has a better selection than department stores, it is more convenient and its prices are competitive and sometimes cheaper. The argument that departments simply cannot compete with Amazon is a realistic one.

What can Kohl’s do about Amazon?

This brings us to the obvious question, what can Kohl’s do about Amazon?

An obvious answer is to start closing stores; Kohl’s closed around 18 of its 1,150 locations last year. Strategic closings particularly of locations vulnerable to online competition; such as stores in sparsely populated areas – would make a lot of sense. The shuttering of low-performing stores would also make a lot of sense.

A more interesting strategy would be to shrink the size and inventories of stores, which can reduce expenses. Kohl’s can compensate for lower inventory by offering instore pickup of merchandise lowered online. The problem with those strategies is that they can reduce revenues by cutting overall sales.

Another is to ramp up its’ online game which Kohl’s is doing. The company has three ecommerce fulfillment centers up and running, and a fourth under construction in Plainfield, Indiana, Zach’s reported.

Growing online is obviously a vital step but it puts Kohl’s in the crossfire of the escalating; and increasingly brutal, online war between Amazon and Walmart (NYSE: WMT). Walmart has been trying to counter Amazon, by dramatically slashing prices at its website and offering more free shipping deals in recent months.

My prediction is that Kohl’s will be able to survive this onslaught if it can reduce its brick and mortar footprint and carve out a niche in the ecommerce world. Despite that investors should sell Kohl’s because I also predict a big fall in its stock price in 2017.