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2001 BW 50

SPRING 2002

STREET WISE

Kohl's: Too Pricey for a Discounter?
This bargain retailer is booming. But the ground could be shifting, even slightly, making it a less-than-sure shot


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Growing up, I spent a good part of my time sulking around stores like Kmart and Ames. Despite my bitter complaining about having to shop at those discounters, mom's frugality won the day. Today, shopping at discount retailers and value-focused department stores isn't nearly the unpleasant experience it once was. Kohl's (KSS ), for one, has even helped make bargain hunting cool. Its strategy of marrying department-store brands to the prices and convenience of a discount retailer has been a winning formula.

It's no wonder the Menomonee Falls (Wis.) retailer (No. 31 on this year's BusinessWeek 50 list of top-performing companies) has been a Wall Street darling for the past several years. Profit growth has been more than 30% per year for six years. Sales continue to exceed expectations. In February, Kohl's posted the best comparable-store sales growth of the major retailing chains: 14.4%. In its fiscal 2001, which ended on Feb. 2, earnings rose to $495.7 million, on revenues of $7.5 billion. The stock price reflects Kohl's performance. Trading at about $68 a share, it's just off its 52-week high of $71 and change.

While Kohl's should be one of the most successful retailers for the long term, in other words, its shares aren't cheap. They carry a valuation of 38 times the fiscal 2002 earnings-per-share forecast of $1.76. That and some new challenges over the next year or so could give new investors pause. "The multiple is reflecting 30% earnings growth. We would be surprised if it pulled that off this year," says Bill Dreher, an analyst with Robertson Stephens. Dreher recently cut his stock-price target to $76, from $87.

WESTWARD HO!  Among the concerns: Kohl's upcoming expansion to the West Coast is expected to be expensive. And although Kohl's and its value-oriented peers have been crushing the competition, discount retailers could see a pullback as shoppers feel better about the economy and start to spread their shopping dollars to stores with pricier goods. At the same time, retailing rivals that have been in turnaround mode are slowly starting to win back customers.

While the Westward move is smart for the long term, Dreher says the logistics of it will be tricky. In the past, Kohl's has had the luxury of stretching capacity at a distribution center in a nearby region while the new area's facility was ramping up. When Kohl's moved into the New York/New Jersey/Connecticut region, it supplied those new stores from its Virginia facility. This provided a smooth transition and kept distribution costs from surging, Dreher says.

The West Coast build-out of 80 stores, beginning in 2003, won't have such a buffer. Instead, the new distribution center, which is being built this year, will have to ramp up quickly to support the new stores on its own. "Costs as a percent of sales will rise," Dreher says. "I don't think the Street is fully aware of the radically different nature of this California expansion." As of February, 2002, Kohl's had 382 stores in 29 states, and the West Coast expansion will take it into at least three more states.

RECOVERY-PROOF?  Kohl's spokesperson Susan Henderson says this situation is no different than any other market the retailer has entered. "Nothing has changed, and our earnings guidance continues to be unchanged," she says.

Meanwhile, the big short-term question for all discount retailers is: Can stellar results continue as an economic recovery takes hold? The shift in the past year toward shopping at Kohl's and Target (TGT ) and Wal-Mart (WMT ) happened at least in part because of the economic downturn. Cost-conscious consumers turned to these retailers for their value pricing.

However, as the nation climbs out of recession, spending habits should change somewhat. Although they probably won't revert to the excesses of boom times, Kohl's and Target shoppers in particular may begin to eye some of the stores they neglected while watching their pennies during the slump.

BACK TO MACY'S?  "Kohl's and Target customers have more choices" because these chains cater to a wealthier audience than do their discount rivals, says Eric Beder, analyst at Landenburg, Thalmann & Co. He expects that these shoppers will still spend a good chunk at discounters and value-oriented stores, but he predicts that they'll also return to department stores like Macy's and specialty shops.

Kohl's remains one of the fastest-growing retailers, and that's nothing to sniff at these days, as many others are struggling just to stay alive. But investors should also be mindful of what the competition is up to. Sure, for the last several years, Kohl's -- along with Target and Wal-Mart -- has been taking share away from the likes of Sears Roebuck (S ), Federated Department Stores (FD ), which runs Macy's, and J.C. Penney (JCP ). "It has been easier for Kohl's to exceed growth expectations when these guys are weak, " says Jeff Klinefelter, an analyst at US Bancorp Piper Jaffray.

However, some of these wounded rivals are engaged in aggressive turnaround campaigns and might actually recapture some of the market share they lost in recent years. That could hurt Kohl's, whose strength has in part come from the lack of significant department-store competition. "What is the chance their incremental share gain will continue if the competition gets stronger?" asks Klinefelter.

DEFECTING BUYERS?  While it may be too early to say that department stores are turning around, some are showing signs of improvement. With strong sales in women's clothes, J.C. Penney reported a 12.5% rise in February same-store sales, topping analysts' expectations. Meanwhile, Sears reported a 3.1% decline in February but said home-appliance and -fitness equipment sold well. Penney stock is down about 14% year-to-date, while Sears has risen 11%.

Kohl's isn't too worried about shopper defections to other stores. "We've gained a lot of new customers over the last year," Henderson says. "Our experience is that once we gain new customers, we keep them."

Most analysts agree that over the long run, Kohl's aggressive new-store growth strategy should pay off and that it's likely to stay competitive throughout the next economic expansion. But while the stock has been a juggernaut, investors should also understand that in the short term, it's more likely to take a breather.


MARCH 25, 2002



By Amy Tsao

Edited by Beth Belton

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