Market Quickly Forgives Kohl's Warning - TheStreet

Market Quickly Forgives Kohl's Warning

Shares dip only slightly on the retail darling's second warning in a row.
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(Editor's note: High-growth retailer Kohl's is a good stand-in for consumer spending. That's why it's in TheStreet.com 21, a new index of 21 companies designed to be a leading indicator of the economy's direction for the rest of the year and beyond. Click here for an introduction to the TheStreet.com 21, and click here for a chart listing the components and their reason for inclusion.)

Kohl's

(KSS) - Get Report

disappointed yet again on Thursday, but investors seem willing to forgive their erstwhile retail darling for now.

For the second-straight quarter, the discount department store chain warned that its quarterly results wouldn't meet its earlier projections. Meanwhile, the company said that its same-store sales, which compare results at outlets open for more than one year, fell in June, marking the third decline in five months.

The immediate reaction on Wall Street was to sell Kohl's stock, and shares fell about 4% in early trading. But by the afternoon, Kohl's shares had regained more than half of their lost ground as analysts rushed in to reiterate previous ratings.

"I'm surprised. It seems like people gave them a pass today," said Fran Radano, a buy-side research analyst at Gartmore Global Investments. "

Kohl's warning was worse than I would have thought, but the market's reaction was better than I would have thought."

Investors have been willing to overlook Kohl's problems for some time now. Despite a disappointing year to date, the company's stock has mostly traded sideways, falling just 5% since the end of last year.

Part of the stock's stability has had to do with the company's past performance. Kohl's has been one of the few bright lights in retail, with a seemingly winning strategy of selling name-brand clothing and other products at discount prices.

For the past seven years, the company has increased its earnings by about 30% or more. Meanwhile, the Menomonee Falls, Wis.-based company has rapidly expanded, opening stores in New York, Massachusetts and California in recent years.

The company's performance contrasts with that of rivals such as

Sears

(S) - Get Report

,

J.C. Penney

(JCP) - Get Report

and other department stores. Many of those chains have struggled with declining same-store sales and little, if any, square footage growth.

But Kohl's has had problems of its own in recent months.

Like many retailers, Kohl's fourth-quarter and holiday sales were

disappointing. Meanwhile, through the first five months of this fiscal year, the company's same-store sales are down 2%, compared with 10.2% growth in the same period last year.

Following a plunge in same-store sales in April, Kohl's

warned that it would not meet its first-quarter guidance. While reporting Thursday that its comparable-store sales fell by 2.4% in June, the company warned that it wouldn't meet its second-quarter guidance.

Instead of earning between 38 cents and 42 cents per share in the second quarter, as it had

projected, Kohl's now expects to earn between 30 cents and 32 cents a share.

Inventory Problems

With sales slow, the company has had mounting inventory problems. Kohl's inventory grew by nearly 28% on an annual basis in the first quarter, far outpacing its overall sales or square footage growth.

When the company reported first-quarter results, Kohl's officials played down concerns about the company's swelling inventory. But the company acknowledged on Thursday that sales took a hit as it tried to clear out the backlog.

"We have been very aggressive on pricing all quarter to clear our seasonal merchandise and be appropriately positioned for back-to-school in August," said company CEO Larry Montgomery, in a statement.

Kohl's expects to have its inventory levels in order in the second half of the year, a company representative said in a prerecorded call.

Despite the disappointment, sell-side analysts largely reaffirmed their optimistic ratings on Kohl's stock.

Looking Past Problems

The reaction of Oppenheimer's Bernie Sosnick was typical. In a research note on Thursday, Sosnick acknowledged that the first half of Kohl's year has been "disappointing." But he blamed the performance on bad weather and reiterated his buy rating on Kohl's shares.

"We consider Kohl's performance

in the first half of the year an anomaly due to the absence of warm weather all through the spring," Sosnick wrote in his note. "We expect the company to return to its normal form in 2H03." Fahnestock, the parent company of Oppenheimer, does not have any investment banking business with Kohl's.

But even buy-siders seem willing to give Kohl's the benefit of the doubt.

Burning through the inventory and turning around its sales may take Kohl's a couple of months, said one hedge fund analyst who asked not to be named and is long the stock. But Kohl's will turn things around, the analyst said.

Kohl's main strength is that it is a much more efficient operator than its competitors, said the analyst. So, while it might have to take the same discounts that everyone else is taking, Kohl's has a better ability to absorb those profitably.

The problem it faced in the first quarter was a combination of bad weather, a slow economy and the Iraq war, which together combined to created one of the worst retail environments since the end of the Gulf War, said the analyst. The company compounded those problems by being overly bullish in its guidance, the analyst said.

"All that stuff will pass," the analyst said. "Their basic model is still intact."

But some on the Street may be growing wary of Kohl's. Sure, the company faced an unfavorable environment in the first half of this year, acknowledged Radano. But the company has always been able to buck those trends and post strong results, he said.

Giving the company the benefit of the doubt may have made sense after one bad quarter, but Kohl's is starting to be consistent about reporting negative news, Radano said. And he doubts Kohl's will be able to turn things around as quickly as the company -- or Wall Street -- expects. Inventory remains a problem, and the competition is tougher than the Street recognizes.

"They're not even coming close to their guidance, which is disheartening," Radano said. "For them to turn on a dime and get some margin seems unlikely."