Louis Wilson Fund - Equity Research
November 21, 2005
Kohl’s- KSS Analysts: Riley Hoekenschnieder & Justin Leblanc
PRICE: $49.08 52 Week Range: $58.9- $43.63
Company Rating: BUY
Reason for Stock Purchase:
Purchase: $ 49 Holding Period
Target sell price: $ 82 Basis for Target Price: Ouma
Kohl’s currently operates more than 670 “off-the-mall” department stores in the United States.
These stores offer moderately priced merchandise ranging from apparel, shoes, accessories and
housewares. With recognizable brand names, they target middle-income customers.
Kohl’s 5-year growth plan includes adding 500 stores and doubling its revenue to around $24
billion. As Kohl’s store base gets bigger, its long-term growth rate will slow and mimic the
growth of more mature retailers like target and J.C. Penney’s. Due to their less costly “big-box”
off mall concept, they are finding that they have healthy operating margins and solid returns on
Driven by new store openings and respectable increases in same-store sales, Kohl’s revenue has
grown an average of 22% annually over the past decade. They have implemented a very lucrative
form of expanding, by opening stores in groups based on their region. They have been able to
save on such things as advertisement and distribution.
Kohl’s has had 20% average annual store growth over the past five years.
J.C. Penney has been putting forth great efforts in orders to reconnect with its consumers after a
five year turnaround effort and is planning to open about 10 off-the-mall stores. Wal-Mart is still
coming on strong in the apparel retail world. Target may also pose a threat.
Kohl’s may also be seeing more competition coming from Linens’n’Things and Bed Bath and
Beyond which may cause problems as almost 20% of sales come from Kohl’s home products.
Kohl’s falls between discount stores and department stores. They carry quality merchandise at a
discounted price. With expansion of their stores still going on in the West, Kohl’s is in a “rapid
growth phase.” They are managing to keep expenses down with their regional openings.
Eventually new store openings will slow causing sales growth to slowly decline.
Management: Laurence Montgomery is has been the CEO since 1999. His compensation in 2003
was just over $1 million, which seams reasonable, and he owns less than 1% of the company’s
stock. Important to note that in 2003 when the company had disappointing performance, no
bonuses were paid to senior management.
Sales growth will slow over the next five years to somewhere around 12%, down from the 21%
that has been maintained over the past five years. Gross margins are expected to stay around
35%, while operating margins will remain steady at 11%-12%, as promotional pricing offsets
improving economies of scale. Free cash flow should continue to improve. (Morningstar)
Kohl’s third quarter ended October 29, with an increase in net income by 15.2% year-over-year to
Total sales increased by 13.7% to $3.1 billion, the value of the average transaction was 1%.
Revenues were also higher than estimated probably largely due to stronger sales in October.
Operating margin increased to 8.6%.
EBIT in the last fiscal year covered interest expense by about 20-times, which is better than the
five-year average of 16-times.
The company’s trailing 12-month return on equity of 16% is below the company’s five-year
annual average, but above those of such competitors as Federated and J.C. Penney.
The company does not pay any dividend at this time, and management has said that they have no
plans to initiate one.
Margins took a bad turn in 2003 after miscalculations on inventories and had to resort to deeper
discounts- however margins bounced back in 2004- Gross margin rose 287 bases points, the
fourth consecutive gain. Kohl’s has since taken steps to improve inventory management and
control costs, and with possible merchandising improvements we may see a boost in same store
Kohl’s PE ratio is 24.3, which is average against its competitors and higher compared to LWF.
The PE Range for Bloomberg and the Value Line had to be slightly altered in my Ouma Model to
reach a more reasonable buy price. I recommend that with a PE of 15 (seems to be a happy
medium), our target buy price should be around $58.
This company fits in with the LWF strategies and would be a strong company for us to hold.
They have strong management- which even through tough times has been able to bounce back; is
building a strong franchise and has taken a significant portion of market share away from its
competitors; has a growing market, which it has been penetrating year by year; has high rates of
return and has demonstrated consistent and growing earning power; and is a relatively strong
financial condition with its low use of debt and marketing strategies. This stock is also not over
valued but shows good potential for growth.
Risks – Why they may not succeed:
One of the greatest risks that Kohl’s faces at this time is loosing their niche in the market of
quality discount merchandise.
If plans for expansion change, for such reasons as greater-than-anticipated competitive pressure
on its margins, we may also see a significant drop in their stock.
Its value relies heavily on cash flows from stores that don’t yet exist.
Some traditional department store chains have copied elements of the firm’s strategy in an effort
to regain lost share.
Weaknesses in demand for moderate apparel.
Significant apparel price deflation.