This Retailer Is Available at a Bargain Price

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Consumer retail is home to the most challenging competitive environment of any sector in the economy. Yet companies like Kohl's (NYSE: KSS) still manage to compete despite having no durable competitive advantages. With larger rivals like Target (NYSE: TGT) and J.C. Penney (NYSE: JCP) treading water -- or worse -- things are looking up for Kohl's.

Able to Compete

Target's revenue is about four times that of Kohl's, yet Kohl's earns higher margins than both Target and J.C. Penney. This means that Kohl's can lower prices below that of Target and J.C. Penney and still earn a profit. This ability to undercut competitors is a key advantage in an industry where price is one of the only effective ways to compete; it keeps Target and J.C. Penney from initiating a price war, which allows Kohl's to earn relatively high margins.

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But Target is not doomed just because its margins are lower than its much smaller rival. Target has a much broader portfolio of product offerings that brings its margins down. For instance, it has large exposure to the low-margin food business. But the company's growth initiatives in Canada should increase inventory turnover which will boost the bottom line. However, Target still has to compete with Wal-Mart and Kroger, which it has struggled to do effectively in the past.

J.C. Penney is also in a decent position to succeed. Under the leadership of ex-Apple executive Ron Johnson, the retailer is in the middle of a total corporate transformation. Johnson's new merchandising and store arrangement strategy is resonating with customers and will ultimately pay off for the company and its investors. However, profits are suffering in the short term due to underperformance in many of the company's legacy stores, which will disappear in the next five years.

Lots Going for It

Kohl's has a lot of things going for it. The company has ample opportunity to expand its presence in North America and its merchandising strategy will continue to drive margins upward. The company's refusal to locate the majority of its stores in malls separates it from the competition and has given it a head start as other retailers are discovering that consumers do not like the mall format.

In addition, the company enjoys high returns on assets. Since 2002, the company has averaged a 20% pre-tax return on tangible invested assets. If this average were applied to the company's current tangible invested assets, it would imply 'normal' pre-tax earnings of $2.9 billion. However, the company earned just $1.86 billion in pre-tax income last year, so $2.9 billion seems a little aggressive.

However, if we assume that the company will earn $1.8 billion in an average year, at a 7x multiple the company is worth $54 per share. If the company continues to successfully expand into new markets, $54 could prove to be too conservative an estimate of value for the company.

Kohl's stock currently trades around $45 per share, so a conservative value estimate of $54 per share makes the stock look enticing; if the company's growth efforts falter, shareholders are still left with a decent return. But if the company's goals are accomplished, then shareholders will reap enormous gains.

titans8904 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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