There is One Last Puff in Kohl's (KSS) Deep Value Play
Wall Street greed has gone too far.
We believe that Kohl's Corporation represents an excellent opportunity to capitalize on Wall Street's greed. Despite a declining business and market sentiment implying imminent bankruptcy (evidenced by approximately 50% short interest), we consider bankruptcy practically impossible given the company's current financial health. Kohl's remains cash flow positive, possesses sufficient liquidity to service all its debt, and has recently appointed a promising new CEO with an impressive track record committed to revitalizing the company.
Currently, Kohl's trades significantly below its liquidation value. The company holds extensive real estate assets, and its debt levels have been consistently declining and remain easily manageable, contrary to market perceptions. It's important to highlight that this retailer has demonstrated an impressive capability to generate free cash flow (FCF), averaging over a billion dollars annually during the past decade.
Four months ago, we wrote about Kohl's, and since then, the company's stock price has declined approximately 50%. We believe this substantial sell-off, especially following their recent fiscal year earnings announcement, presents an ideal entry point. Now equipped with clearer insights into the new CEO’s strategic initiatives, investors have an attractive opportunity to initiate a position or increase their existing holdings.
FY 2024 Review and Earnings Call
The company surpassed Wall Street expectations with an adjusted EPS of $1.50 for FY 2024, despite net sales decreasing by 7.2%. However, shares dropped approximately 20% following weaker-than-anticipated guidance. Operational cash flow was $648 million, and the company successfully reduced long-term debt by $113 million. Kohl's projected EPS for the upcoming fiscal year is between $0.10 and $0.60, anticipating a further net sales decline of 5% to 7%, alongside a reduction in the quarterly dividend to $0.125.
In our view, this guidance appears overly conservative and likely includes provisions for potential tariff impacts. We found the new CEO's statements particularly encouraging. He explicitly acknowledged the necessity of refocusing on customers—prioritizing straightforward retail leadership in price and quality over complicated metrics or financial targets. With over 30 million loyalty customers, Kohl's has a substantial and historically underserved customer base. The CEO's focus on simplicity is especially promising, as simplicity tends to foster scalability and efficiency.
Over the coming year, Kohl's will complete its Sephora store rollout, significantly reducing future capital expenditures and thereby increasing cash flow. The Sephora partnership has already shown considerable success, and management will now shift their efforts toward improving comparable store growth.
CEO
Ashley Buchanan, aged 50, brings a wealth of experience to Kohl’s, notably having spearheaded the development of Walmart’s e-commerce business before serving as CEO of Michael’s. During his tenure at Michael’s, Buchanan successfully orchestrated its sale to Apollo Global Management at a 78% premium for shareholders and continued as CEO until his recent appointment at Kohl’s.
Examining Buchanan’s compensation packages provides insights into his alignment with shareholders' interests. At Michael’s, Buchanan's compensation included a signing bonus of approximately $3.7 million, an annual salary of $1.2 million, stock awards totaling $6.9 million, and option awards of $1.5 million, aggregating around $13.2 million. In comparison, at Kohl’s, he received a signing bonus of $3.75 million, a salary of $1.475 million, and notably, $17 million in Restricted Stock Units (RSUs). Buchanan's choice to take most of his compensation in stock clearly demonstrates his confidence in the company's future, a strategy inconsistent with a business heading toward bankruptcy.
Since joining Kohl’s in January, Buchanan has implemented decisive measures, including store closures, a 10% workforce reduction, and exploring operational efficiencies—such as assessing the impact of discontinuing Amazon returns in select locations. His strategic approach, as presented in the latest earnings call, prioritizes regaining Kohl’s foundational appeal: quality merchandise, attractive pricing, and enhanced customer experiences. Buchanan’s initial actions, including the reduction of dividends to bolster debt refinancing capabilities and potential future share repurchases, signal a thoughtful and proactive leadership strategy aimed at long-term recovery and growth.
Debt
One of the most significant misconceptions about Kohl’s is its perceived large debt burden, often cited as around $7 billion in net debt, suggesting a highly leveraged business. However, a closer examination reveals a different reality. Kohl’s actual debt position comprises approximately $643 million between revolving credit borrowings and current maturities due in July, along with an additional $1.17 billion in long-term debt. This results in a genuine debt obligation of approximately $1.8 billion. The remainder of the reported debt figure consists primarily of lease liabilities, which, despite being capitalized, do not represent traditional debt obligations and typically can be renegotiated at significantly lower amounts in distressed scenarios.
With the planned refinancing of July maturities, Kohl's will face no additional debt obligations until 2029, providing ample flexibility for the CEO to enhance operational efficiency and economic performance. Even in adverse conditions, such as a recession or continued weakness in retail—especially impacting Kohl’s core value-focused consumer segment—the company retains significant flexibility. The substantial real estate portfolio could be monetized, benefiting from increased property valuations driven by recent inflationary pressures. Historically, private equity interest in Kohl's real estate assets underscores the inherent value and potential liquidity available to the company.
Real estate.
Arguably the most compelling aspect of Kohl’s is its extensive real estate holdings, currently recorded at around $7.3 billion, largely depreciated due to their historical acquisition. Despite a recent decline of 10-20% from 2022 peak valuations, the commercial real estate market has significantly appreciated over the past decade, attracting considerable interest from private equity firms and activist investors aiming for sale-leaseback transactions.
Kohl’s owns 410 of its 1,150 stores, most being 80,000-100,000 square-foot spaces in highly attractive outdoor strip centers, suitable for industrial or alternative retail purposes. Only 5% of these locations are situated within malls, with 13% freestanding. Recent store closures further highlight opportunities to monetize these assets, as detailed in analyses such as this informative article:
In a conservative scenario, we estimate Kohl’s real estate portfolio's value at approximately $4 billion, with optimistic valuations reaching $8-10 billion if market conditions improve. A key downside risk would emerge if Kohl's stores become unprofitable and unable to cover lease obligations, requiring lease liabilities to be viewed as genuine debt. However, management has consistently asserted that nearly all stores remain cash flow positive, even amidst challenging retail conditions. Although a sale-leaseback transaction is plausible, current financial conditions could deter immediate interest. Offers from potential buyers and activist investors are likely to re-emerge once the company achieves greater stability.
Conclusion
Considering real estate assets minus debt, Kohl’s intrinsic value ranges conservatively between $22 and optimistically up to $70 per share, with the higher valuation less probable. For a cash-flow-generating company trading significantly below liquidation value, managed by an incentivized CEO, a 50% short interest reflects excessive Wall Street pessimism. While we view Kohl’s primarily as a reversion-to-the-mean investment with numerous catalysts in the foreseeable future, investors should allocate cautiously and consider incremental buying should the share price decline further.
Disclaimer:
The information provided in this article is for informational purposes only and should not be considered financial advice. The content does not constitute a recommendation to buy, sell, or hold any security or investment. Always do your own research and consult with a professional financial advisor before making any investment decisions. Investing in stocks involves risk, including the potential loss of principal. Past performance is not indicative of future results.