Is Kohl's a Train Wreck After it Failed to Impress Like Macy's?

Last week wasn't a great time to own shares of Kohl's , a clothing retailer with an $11.6 billion market capitalization. After reporting earnings that were, let's say, less than ideal, shares of the company fell more than 8% to close at $53.55. This bad earnings release just goes to show that many retailers have not been as fortunate as Macy's  lately. Rather, it brings to mind the image of a J.C. Penney in the making.

Earnings bombed
For the quarter, Kohl's saw revenue decline by 1% to $4.44 billion from the $4.49 billion it reported in the same quarter a year ago. This decline occurred despite the company adding three stores to bring its total number of locations up to 1,158. The primary driver behind the company's lower sales was a decrease in comparable-store sales of 1.6% compared to the same quarter last year.

At face value, a 1% decline in sales looks unappealing, but far from a death spiral. However, when combined with net income declining by 17.7% from $215 million to $177 million, the story starts to look a tad bit worse. According to the company's earnings release, the decline in net income came about while costs increased as a percentage of sales. This can be seen by looking at the company's cost of goods sold, or COGS, which rose from 61.9% of sales to 62.5% of sales this quarter. Though not a large portion of the charges, the company also saw depreciation and amortization rise by 8.6% due to the timely write-off of newly acquired assets.

The decline in net income resulted in earnings per share that were lower than expected. For the quarter, Mr. Market expected the company to post earnings of $0.86. At $0.81, a 5.8% shortfall from estimates and an 11% shortfall from the $0.91 it reported last year, the situation at Kohl's looks far worse than what investors imagined. This poor result flooded over into the company's full-year earnings forecast, which was cut from a range of $4.15-$4.35 to a range of $4.08-$4.23.

On a positive note, the company saw its liquidity improve as its current ratio rose from 1.57 to 1.64 and its cash flow from operating activities increased by 44.2% from $703 million last year to $1.01 billion. However, these changes are likely temporary because the bulk of the fluctuations reported were primarily due to inventory changes, not because of increased earnings.

Kohl's can't seem to handle the heat
The retailer's lackluster results stand in stark contrast to Macy's, its $19 billion market cap competitor, which reported earnings the day before Kohl's. Unlike Kohl's, Macy's crushed forecasts with revenue rising by 3.3% to $6.28 billion. The primary driver behind its earnings beat was a 3.5% rise in comparable store sales (4.6% if you account for its store-within-a-store setups).

If this weren't enough, the company saw a significant uptick in its bottom line, with net income rising 22.1% from $145 million to $177 million. This was due in part to sales rising, but it was also due to an improvement in the company's ability to maintain costs.

But could it come to look like this?
With Kohl's seeing its metrics deteriorate, I have to wonder if it might be going the way of J.C. Penney. Over the past few years, J.C. Penney has been hit hard. Although sales were declining for a few years prior to its downturn, the retailer was slammed in 2012 with sales declining by 24.8% to around $13 billion. Its fall from grace was the product of poor management decisions, combined with consumers moving away from brick-and-mortar shopping.

Over the past few months, management at the chain has kept investors aware of improvements in its business, but a recovery is a long way off. Now, Mr. Market needs to see if Kohl's will see a similar decline in the years to come or if management can successfully win back its customer base before experiencing a similar decline in its fortunes. Sales for the retailer just began to fall last year, so any substantial decline in Kohl's top line or bottom line could be disastrous, which should entice investors to stay on their toes and watch any news released very carefully.

Foolish takeaway
Right now, the situation for Kohl's is less than ideal and doesn't look to be getting much better. After its disappointing earnings release, investors are right to wonder if it will be the next J.C. Penney, though it is still too early to tell for sure. While it is possible that Mr. Market overreacted to Kohl's announcement, I believe there is a good deal of risk in being a shareholder, but with risk comes reward if your conviction is right. Personally, I would much rather play it safe and stick with Macy's.

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