We see signs of improvement in the second quarter and view shares as fairly valued.
As we expected, Kohl's
top-line declines and operating margin showed signs of improvement in the second quarter given national brand and speed to market initiatives as well as cost and quality of sale plans. That said, we continue to think that there is a limit to the returns that can be driven by company strategy and view a return to top-line growth and margin improvement as difficult to come by with traffic trends remaining negative both for the company and the industry and shifts to e-commerce causing secular pressure to operating margin. Therefore, we see little change to our $42 fair value estimate which is based on a 1% average annual revenue decline over the next five years (in line with second-quarter performance) and adjusted operating margin declining from 7% in 2016 to the low-6% range in 2021 given mix shifts to e-commerce. We think these risks are well understood by the market and see shares as fairly valued.
Bridget Weishaar is a senior equity analyst for Morningstar.
We think that management’s efforts to defend against industry headwinds are seeing some success with both top-line and margin stabilization. Second quarter’s 1% top-line decline (with comparable sales down 40 basis points) was an improvement over the almost 3% decline in sales in 2016. Management noted that transactions improved (although they remained negative) but that improvements in average unit retail (lower clearance sales) were offset by units per transaction. Footwear was a strong performer, driven by athletic shoes and both national brands and private label performed well. National brand penetration increased 300 basis points to 53% on strength in brands including Levi’s, Van Heusen, and Fitbit. However, we think that the company could be reaching a limit to the improvements it can recognize through strategic improvements as industry headwinds show no signs of abating, and we view this company as lacking an economic moat. Therefore, we expect average annual revenue declines to continue over the next five years.
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