Growth stagnation hampers value expansion
The post was originally published here.
Highlights:
- Strategic partnerships to escape growth stagnation
- Activist investors increase pressure after poor performance
- Ramp-up of share repurchases spices up returns
Q1 2022 hedge fund letters, conferences and more
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Price signal unclear, volume is bearish
- Share price has been flat for years
- Recently, the 50 DMA has fallen below the 200 DMA
- Both lines converged leaving an unclear signal
- The RSI-Volume stayed below the 50%-line which suggest a bearish signal
Kohl’s revenue breakdown 2021
Strategic partnerships to escape growth stagnation
- Kohl’s entered a partnership with largest US specialty beauty retailer, Sephora
- The agreement moves Sephora’s shops to Kohl’s locations
- With a 25m customer base, Sephora could bring more traffic into Kohl’s stores
- 200 Sephora stores already opened with an additional 400 planned by 1H22
- The partnership could bring Kohl’s revenue back to over US$20bn
Activist investors increase pressure after poor performance
- In Dec 2021, an activist hedge fund called for a split-off of Kohl’s e-commerce business making up around 29% of revenue
- The hedge fund values the e-commerce business as a stand-alone business more than the total market cap of Kohl’s
- It also suggested another way to unlock value by delisting Kohl’s and selling it to private investors
- Although unlikely to be successful, it increases pressure on management to improve the business to increase share price performance
What is an activist investor?
- Activist investors are an individual or group of investors with a significant stake in a company, who aim to influence or make material changes to how the business is run. Changes like:
- Board composition
- Share repurchases and dividends
- Advancing ESG issues
- Privatization of the business
- Spin-off of business segments
- Divestitures of inefficient segments
It’s not the first time that Kohl’s has been targeted
- In early 2021, activist investors with around 9% share aimed to take control of the company’s board
- Kohl’s share price has chronically underperformed the market
- As a compromise, Kohl’s extended its board to include two directors nominated by the investor group
- This investor activism appears to be a good wake-up call for Kohl’s management to reengineer its flat business
Ramp-up of share repurchases spices up returns
- Kohl’s has a strong commitment to return as much cash as possible to its shareholders
- The dividend yield could return to 5% in 2022
- In addition, activist shareholders pressed to get a commitment to a new share repurchase program worth US$2bn
- Even if the share price were to stay flat, investors could still enjoy attractive returns
FVMR Scorecard – Kohl’s
- A stock’s attractiveness relative to stocks in that country or region
- Attractiveness is based on four elements
- Fundamentals, Valuation, Momentum, and Risk (FVMR)
- Scale from 1 (Best) to 10 (Worst)
Consensus remains cautious but sees upside
- Most analysts still have HOLD recommendations
- The poor share price performance over the past two decades has made analysts skeptical
- They forecast that the increased profit margin is likely to fade over the next two years
Get financial statements and assumptions in the full report
P&L – Kohl’s
- Net profit has a strong rebound and exceeds its pre-pandemic level
- The strong bottom-line is mainly driven by the margin expansion
Balance sheet – Kohl’s
- As of 2021, the company holds a record US$2bn in cash which it will distribute to its shareholders over time
- The company continues its massive share repurchase program which is the main driver of increasing EPS over time
Cash flow statement – Kohl’s
- Strong operating cash flow allows the company to pay out dividends which are in line with its pre-pandemic policy
- We expect that the dividend yield over the near-term to range between 5-6% like in 2019 and 2020
Ratios – Kohl’s
- After the revenue rebound in 22E, we assume revenue growth to normalize
- Going forward, we see poor revenue growth potential between 2-3%
- EBIT margin expansion in 22E probably only short-lived
- Going forward, we see the EBIT margin to range between 7-8%
Long-term share price performance potential
Free cash flow – Kohl’s
- Strong cash flow generation is crucial for returning cash to shareholders
Value estimate – Kohl’s
- Like consensus, we expect a slightly stronger margin compared to the past
- The revenue growth CAGR is distorted by growth rebound in 2022
- Expect lower growth 23E onward
World Class Benchmarking Scorecard – Kohl’s
- Identifies a company’s competitive position relative to global peers
- Combined, composite rank of profitability and growth, called “Profitable Growth”
- Scale from 1 (Best) to 10 (Worst)
Key risk is falling behind in online sales
- Activist investors might not decide in favor of the long-term future
- Increased transportation costs and worsening of inventory management
- Failure to keep up with e-commerce could lead to lost of market share
Conclusions
- Don’t expect high growth, but price discount offers upside
- Intervention of activist investors could be accretive
- Attractive dividend yield and share repurchase program can be satisfying enough
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Article by Andrew Stotz, Become a Better Investor.
