Kohl’s has had a difficult time sustaining it’s top-line growth, due to their failed initiative of  pushing private-label inventory (to increase profitability) which resulted in diminished growth.

As a result, Kohl’s is shifting it’s inventory mix to include more national labels. This act comes at the expense of profitability.

While Kohl’s generates healthy cash flow (and prudently allocates a large proportion of it to shareholders), total payout as a % of LFCF has been increasing significantly.

The consumer discretionary sector has been pumelled recently, due to poor results from department stores Macy’s and JC Penny. In lock-step w/ the rest of the sector, KSS has seen significant multiple compression. It is currently trading at 10.9x P / NTM earnings w/ a 1 year average of 12.2x and max of 17.4x. Upon further evaluation of its historic valuation, the 17.4x max seems unjustifiable (or more indicative of animal spirits associated with lower oil prices). It’s 3 year average and median equal 12.6x and 12.3x, respectively.

At 5% EPS growth and gravitating towards its 1-year historical valuation, KSS represents a potential 16.4% return (to $52.51 / share), representing an illustrative upside case to current (the street expects ~ 3-4% EPS growth for the next few years).

Back of the envelope math:

I’d like to see the following with respect to KSS becoming an enticing equity play:

• Higher traffic in store
• High capture rate of customers in regions where Macy’s, JC Penny, and Sears/K-Mart stores are closing down
• Increased gross profit dollars (lower margin + higher revenue) from “Greatness Initiative”
• Experimentation w/ smaller format stores
• CapEx experimentation w/ new tech (variable pricing) (although I understand this is not generally in Kohl’s culture)