RealMoney Silver - KSS Preview: Square-Footage Cuts in the Works?

KSS Preview: Square-Footage Cuts in the Works?
By Ron Thomas
RealMoney Contributor
5/14/2008 3:58 PM EDT

Since the fourth quarter was reported, I believe that some of the longer-term margin-widening story has come out Kohl's (KSS) , which has rallied from $45 to $49 with the rest of the retailing group. I question whether the upside surprise of a 3.5% April comp is very sustainable, but it is no particular surprise that some of its newer brands in children's and men's continue to have some impact.

Leading retail indicators point to somewhat slower sales in the second half of this year after the tax rebate wears off. In this sort of environment, I will agree that Wal-Mart (WMT) has the final say on whether the money is even going to do much good for retailers in the short term, and the company has obviously spoken negatively on that. I would take Wal-Mart's comments as a negative leading indicator for second-half sales for the entire industry as well.

Kohl's at $49, using consensus EPS for this year and next of $3.11 and $3.55, respectively, discounts a 10% five-year EPS compound annual growth rate (CAGR), which is about what I believed the CAGR would be in my fourth-quarter note. At this point, I think that a 14% earnings growth, to $3.55, is a fairly unlikely increase, and $3.55 probably represents at least a good normalized EPS level. If I tweak my standard model of five-year EPS growth with a five-year decay rate to terminal growth (which I do not believe for Kohl's) to a three-year decay rate to terminal growth (after a five-year growth rate, which I still think gets Kohl's past the point of store saturation), the stock discounts a 12% EPS CAGR.

Home Depot (HD) may be telling us something about longer-term consumer spending overall, not just in the home-related space, with its decision to effectively cut out square-footage growth. Kohl's management will obviously be asked about this, and it will be the most important answer given. If management makes a big square-footage growth cut (which I do not expect, since the company does have some growth left), by itself or in concert with JCPenney (JCP) , Target (TGT) , etc., the question then becomes whether the long-term sales growth increases have become much worse than management or investors previously thought they were.

The positive side of this is obviously that there will be an increase in return on investment capital (ROIC) from present levels, longer term. I would like to see the square-footage growth rates in the department store sector cut, but I do not know what the ROIC increase would be. It might well be less than many investors would expect.

Meanwhile, Kohl's latest first-quarter EPS estimate is 44 cents vs. 64 cents a year ago on a 1.5% sales increase, to $3.63 billion. With the tax rebates in the next quarter's EPS, at least, I believe that EPS strength will tend to be overlooked by the market but that a negative result relative to market expectations my end up being priced in.

Regarding competition, I had been somewhat more concerned about what Macy's (M) would do to gain back market share, as its disarray has obviously been a tailwind for Kohl's, especially in the Midwest and with Kohl's new brands probably gaining share at its expense. With Wal-Mart having been so negative and gasoline possibly becoming $3.50 to $4.00 permanently, I think that Target will end up being the bigger incremental competitor.