Compared to a weak first quarter that raised yellow flags, Kohl's (KSS - Get Report) certainly delivered better spring season results. The improved performance must have been a relief for shareholders, especially after peers Macy's (M - Get Report) and Dillard's (DDS - Get Report) missed the mark by a mile in the second quarter of the year.
- Kohl's is Jim Cramer's Real Money Stock of the Day
- In This Retail Environment There Is a Place for Kohl's
- Kohl's Can Rally in the Short-Term but a Proper Base Will Take Longer
However, this is not to say that the risks associated with investing in this stock, including exposure to increased tariffs in the second half of 2019, have waned.
Investors Breathe a Sigh Of Relief
Perhaps the most encouraging news of the day is that Kohl's experienced an increase in sales that eventually led to positive comps in the back half of the period, despite reporting same-store sales that missed analyst expectations for the whole quarter. The back-to-school season, the retailer's second most important period in the year, is shaping up to be a solid one. This is not surprising, since the departments that tend to benefit the most from the fall season, including active wear and children's, have been performing better than average for a while.
In addition, a couple of Kohl's key growth initiatives seem to be panning out. First, the increase in digital sales accelerated to mid-teen percentage levels, in part offsetting soft in-store sales that did not seem to have improved much from the previous two quarters. Second, the management team reinforced the benefits of the company's merchandise return partnership with Amazon (AMZN - Get Report) , resting upon it hopes for better foot traffic in the foreseeable future.
Key Risks Remain High, However
Despite the positives, Kohl's failed to put to rest some of the main risks associated with investing it its stock. Certainly, the recency of the retailer's sales growth pickup is something to be considered, since key product categories, especially women's apparel and footwear, remain under pressure. But probably most significant is the debate around the impact of increased tariffs on the company's margins.
In the earnings call, the management team seemed confident that the company will be able to address the trade-related challenges well by working closely with vendors to minimize supply chain disruptions and merchandise costs. But CEO Michelle Gass' remark that "customers will still receive the value that they expect" suggests, not surprisingly, that price reductions will likely be needed to protect Kohl's market position in the face of higher import taxes, given the competitiveness of the department store space.
These pressures were reflected in management's decision to trim gross margin guidance for the year, which is now expected to land somewhere between 35 and 45 basis points lower than last year's levels. The outlook for net earnings per share remained unchanged, but probably only due to expectations for more aggressive stock repurchases and optimism over improving sales trends going forward.
Still a Stock To Avoid
Although Kohl's performed better than many feared in the second quarter, I continue to believe that the stock poses more risks than opportunities at current levels. Sales have started to recover, but only barely so, while the crucial women's category continues to lag. And margin pressures are plentiful, including higher tariffs kicking in ahead of the holiday quarter, lack of pricing power, and increased operating costs to support digital channel growth and the partnership with Amazon.
In the retail sector, I believe better opportunities can be found in the off-price and direct-to-consumer spaces, while traditional department stores are likely to suffer the most from macro-level headwinds.
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