Kohl's: How Do They Do It?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For reasons beyond my control, I've spent quite a few hours of late joining my wife on some of her recent shopping ventures at Kohl’s (NYSE: KSS) which suffice it to say isn't topping my list of things I like to do.  I really can't complain too much, not only do I really enjoy spending time with her but on one such venture she bought me a Keurig from Green Mountain Coffee (NASDAQ: GMCR) with a variety of k-cups to enjoy.  As we were talking about which model to buy and what k-cups to snap up she was educating me on their sale prices on top of 20% off coupons on top of Kohl's cash.  Being the Peter Lynch type where every experience can be an investing lesson I began to wonder how Kohl’s actually made money if we were getting such a great deal.

After one last trip where we were looking to spend her $40 worth of Kohl's cash earned from our aforementioned Keurig purchase we walked out of the store having spent a grand total of just over three bucks out of pocket yet went home with close to a hundred dollars’ worth of merchandise.  It was then that I realized I needed to dig a little deeper into their financials if nothing more than to see if they actually turned a profit.  A quick glance at their latest earning release opened my eyes faster than a cup of Starbucks Coffee brewed from my Keurig!  For FY 2011 they had $1.1 billion dollars of free cash flow, which is exceptional for this $12 billion company by market cap.  They are trading just under 12 times earnings and 11 times cash flow, which is right about the price I start to get interested.

The numbers don't lie, Kohl’s is highly profitable but how do they make money if my wife and women like her are walking out of their stores with such great deals? I posed a very similar question to my friends on my face book page by asking why they shopped at Kohl’s in the first place.  The overwhelming response was around the pricing or the deals when considering the quality of the items you can pick up.  So while the discounting and promotions certainly drive traffic what it really drives is customer loyalty.  If they get a great deal on an item they really want they’ll come back later to pay a fair price form something they need.  Kohl’s goes out of their way to ensure their core customers stay happy but they are always looking at how to win the next generation.  It’s not just about trendy tops for teens; they start much younger than that as one of my friends posted, “My four year old like it because they have little potties in the bathroom.  Every time we drive by, she says, there’s the store with the little potty!”  Kohl’s goes out of their way to ensure their customers are treated very well and have no barriers to keep coming back. 

Kohl's customers don’t have to leave the comfort of their own home.  Their e-commerce business passed the billion dollar sales threshold last year or about 5% of their total sales.   One of the key drivers of their e-commerce business as well as their brick and mortar business is their Kohl’s charge cards which are their most loyal customers.  They speak very highly of their relationship with Capital One (NYSE: COF) as the cards drive higher annual spend than non-cardholders.  They are planning to use these tools to drive more sales in the future as they work to drive revenue by volume while working to keep their general costs down in order to keep up their profitability levels. 

As an investor it is difficult for me to get too excited though when I look at their growth profile.  They are only plan to add 40 stores to their base of over 1,000 stores this year and at this point only 20 annually going forward.  This leads to management only expecting a 4.5% increase in total sales with a paltry 2% increase in comparable same store sales.  Yet on the value side of things they are not much cheaper than Target (NYSE: TGT) which trades at around 13 times earnings and a similar growth profile.  While Kohl’s appears to be growing their earnings by 10% over the next year, most of that increase is due to their shrinking share count through their $3.5 billion dollar buyback through 2013. 

While I am intrigued by the cash flowing out of Kohl's to shareholders in the form of massive stock repurchases followed by its very stylish 2.5% dividend, I'm not ready to load up my shopping cart just yet with the stock.  I think that the stock is very reasonably priced if not selling at a discount; it just doesn’t fit my investing style.  I am still going to add this one to my watch list, as I think long term investors buying here will do really well.  It’s just not deeply discounted enough nor is it growing fast enough for my investing tastes.  If they ever send investors one of those 30% off coupons that my wife adores that’s valid on the stock, I’d be a buyer.


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