In the living hell that retail-sector investing has become,
stands as a shining city on the hill.
Its shares are up about 3% this year, compared with drops of 20% or more for stalwarts such as
. Now its shares trade at 42 times estimated 2001 earnings, higher than Wal-Mart's P/E of 34. Why? It's projected to grow earnings at about 23% annually, compared with about 15% for Wal-Mart and Target. And amid the current market freakout about interest rates, investors are concentrating their spending on a few growth names, particularly in the less rate-sensitive value retail segment.
Over the next two months, Menomonee Falls, Wis.-based Kohl's is due to make a big push into the Northeast, opening 33 stores it bought from now bankrupt
last year. A hedge fund manager and several analysts say the Northeast move may serve as a catalyst for further increases in Kohl's shares. Wednesday,
Deutsche Banc Alex. Brown
started coverage of Kohl's with a strong buy and set a price target of 90. The stock closed Tuesday at 75 13/16. Alex. Brown hasn't done any banking for Kohl's.
"In this business right now, the market will pay almost anything for market-share winners," says the hedge fund manager, who has a modest long position in Kohl's and didn't want to be named.
Big Boxes, Big Brands
First, it's necessary to understand where Kohl's fits on the general merchandise continuum, which stretches from
on down to
. Kohl's has made its name by taking the best of the department store and discounter worlds. Like department stores, it sells brand-name goods like
. But it has a higher ratio of name brands to private-label goods than
analyst Shari Schwartzman Eberts -- 80%/20% compared to their 50%/50%. (She rates the company a buy, and her firm hasn't done any recent banking for the company.)
Big Box Boom
Also unlike its department store rivals, which may send shoppers wanting to buy lingerie traipsing through the housewares department in search of a clerk, Kohl's has big box stores with centralized checkout facilities. And it has shopping carts and wide aisles, making it more friendly for customers with rugrats.
Kohl's also sends out weekly circulars promoting specials, which gives the perception that it's a bargain-hunter's paradise. In fact, said
analyst Jeffrey Edelman in a recent research note, about a third of merchandise sold at Kohl's is at regular price, which is always nice for margins. (Edelman rates Kohl's shares attractive and hasn't done any recent banking for the company.) While consumers want the lowest price, they'll also pay regular price if they perceive they're getting value and convenience, writes Edelman.
All this gives Kohl's a niche that's likely to appeal to New Jersey, New York and Connecticut shoppers, particularly when compared with competitors like Penney and Sears, which are looking a little frayed around the edges. "The new beats the old," says the hedge fund manager. "The question is whether it executes well enough in its opening to convert people permanently?" He thinks it will, as it has in other new markets like the mid-Atlantic.
Where the Money Is
The East Coast has another advantage, too: a high population density and concentration of wealth. J.P. Morgan analyst Eberts figures that Kohl's has invested about $18 million per old Caldor store (including construction, inventory, preopening and capitalized rental expenses) as opposed to the $13 million it usually spends on new stores. But those Caldor stores, while more expensive to develop, will generate about $30 million in annual sales, compared with about $20 million for other stores. That means the $142 million Kohl's paid for its Caldor locations -- which many thought to be on the high side when Kohl's announced the purchase -- will likely prove to be a smart move.
More cynically, Kohl's may see a bounce now that it has locations closer to where money managers live. Once they hit the aisles on the weekends and get the Kohl's thrill themselves, the theory goes, they'll be more receptive to the company's story. (Kohl's is expected to detail its expansion when it reports earnings early this month.)
Of course, any move into new markets means risk. And the risk increases as interest-rate fears continue, and as Kohl's stock price marches steadily higher. If it reaches into the 80s, it approaches priced-for-perfection territory, says the hedge fund manager. That means the company won't just have to meet expectations for its latest batch of stores, it will have to exceed them.
If it can pull off this move to the Northeast, though, and in the process steal market share, investors may be willing to keep paying up. There are plenty of bargains in the retail sector. Companies with sales and earnings growth prospects and a proven track record are far more rare.