Kohl's Corporation (KSS) Earnings Call Transcript & Summary

Can you hear me? All right. Wonderful. Well, thank you, everybody, for joining. I'm Mark Altschwager, senior research analyst from Baird. And it's my pleasure to introduce management team from Kohl's. Kohl's is one of the nation's leading omnichannel retailers. We have Tom Kingsbury, who recently took over as CEO; and Jill Timm, Chief Financial Officer. Start out here. Tom, you've had a very successful career, including about 12 years at Burlington before retiring in 2020. You're now back in Menomonee Falls, Wisconsin, which is your hometown. You're leading Kohl's, which is your alma mater, really driving to improve sales and profitability. It would be great to start out and just hear you talk about what motivated you to take the role.

Okay. Well, I thought I retired at the perfect time, February of 2020. So I got through that, and now I'm back working again at Kohl's. Kohl's is a really great company. I've actually been involved in Kohl's since 1958 when my father came from Ohio, took us from Menomonee Falls. And he started working there. And it was a grocery store when he started and obviously grew into the department store business. So I'm very familiar with Kohl's. Obviously, I grew up in Menomonee Falls and went to the University of Wisconsin. So I've always had this really close, close relationship, even though I worked at many department stores for 30 years. My last one was at Filene's in Boston, and then came to Kohl's for 3 years -- 2.5 years as one of the principles there and then left and ran Burlington for 12 years. Again, I think Kohl's has a very, very strong foundation. They have a great team that's really committed to win. And the fundamentals are very strong. So I came back, I was sitting on the Board and then came back. And after Michelle left, I tried out back and the Interim CEO, then I became permanent CEO. But I think in terms of our strategies that we put in place early, we're already seeing traction on those. We feel very good about that. The first quarter was basically what we anticipated. So we think we have things going in the right direction. And again, we have a team that's in executed.

We'll get into more details around some of the specific priorities. But now that you've been in the role for a few months, just how are you feeling about the opportunity for Kohl's? What are some of the good things, some of the bad things that have set out for you in the first 6 or so months?

Well, there's multiple things that have been very good. Our relationship with Sephora has been terrific. We opened 200 stores in '21, 400 stores in 2022. And then we're opening up another 250 stores in '23 in the larger size box, which is about 2,500 square feet. So the first 200 stores that we opened are comping like mid-teens. So very, very strong. We're beating plan in the next 400, and we're going to open -- the next 250, we're going to have 200 opened this quarter and then 50 the next. And then we decided that we needed a smaller format, a 750 square foot store, so we went from 2,500 to 750 square feet. We brought in 5 stores, we set up 5 shops. We're so good that we quickly went and we're going to add another 45 in the third quarter. So starting in '21, by 2025, it's going to be a $2 billion business for us. So that's something that we feel isn't helping us now, but it's going to help us lot in the future. We're seeing a different customer come into our stores, a new customer. So 30% of the customers that are coming in to shop support Kohl's are new to Kohl's. So that's a pretty significant number when you think about that. It's pretty exciting overall. So that is a very, very strong strategy. The other big opportunity is our home business. We've been -- we're underpenetrated there. And there's a lot of categories that we can grow, okay? Specifically, the home decor business. We don't have the presentation we really need to do that. We started in the first quarter to really build a product. Some of it is coming in now, come in the balance of the second quarter. But we really think the second half of the year, we're going to really go after that business as well as the pet business. We weren't in the pet business until last year, which we really feel is a big opportunity. Gifting business. We're changing how we present in our stores. So we've dedicated some front of store real estate for gifting because we want to be a destination for gifting. We made some moves in the fourth quarter, brought a lot of Christmas gifts to the front and the stuff blew out. We did it for Valentine's Day, Easter, Mother's Day, now we have American presentation going on. So that's been very good opportunity in storage, impulse, et cetera. So that's a huge opportunity. And it's one of the things that I learned a lot about when I was running Burlington, the off-price market does that extremely well. We're really changing our strategy as it relates to women's apparel. We got too heavy into active and casual, and we're a little late to come to the party on bringing in dresses, polished casual. People are going back to work now. So -- and we didn't have the product until the first quarter. So dresses outperformed the company once we got the product on to the selling floor. The same with men's. The men's business, too much active and too much casual. And -- but now we're selling a lot of suits, dress shirts, et cetera. So there's really big opportunities in our stores as well. We really haven't had an increase in our -- volume in our stores for ever, for a very long period of time. The only time we did is when -- in '21 when we were up against the store closures in '20. So really highly profitable part of the business for us. And we saw a positive comp in the first quarter. And we really feel that, that's going to be obviously a very strong business for us.

Stepping back, bigger picture. As we look at the retail space, we've seen success with brands at the high end where consumer spending power has been a bit more resilient. And we've also seen success with deep value. Where do you see Kohl's key points of differentiation in today's retail landscape?

Well, I think the fact that we do have a lot of national brands on our selling floor. 70% of our sales come out of national brands, names you all know like Nike, Under Armour, Tommy Hilfiger, Eddie Bauer, et cetera. I mean we have a really nice portfolio of brands. And they're -- they did very well in the first quarter. They outperformed our proprietary brands. So our difference is having a lot of brands, also having the value equation of our proprietary product as well. So -- I also think we're different than other department stores. I really want to emphasize that because where the Kohl's stores are located, they're not in malls, okay? Less than 10%, right, are in malls. And -- so we have a freestanding strip center present location. We sit next to the off-price guys, we sit next to Target, et cetera. So we really feel that's an advantage for us that makes us different than the other department stores. And -- so those are really the big differences overall, the brand portfolio we have and where our stores are located, which I think is obviously incredibly important.

That's great. In the last couple of months, you've had a new chief merchandising and digital officer joined the company, along with the chief operating officer. What should investors know about the team that you brought together?

Well, we feel very good about the team. We worked hard, and I'm very thorough to bring in 2 really strong individuals to our management team. Nick Jones, he is from the U.K., but he has a background in Asda which is the Walmart division in the U.K. So he knows value very well. He also had -- did a lot of work on private brands for their company as well. So not only does he understand value but he also understands how to build product overall. And then Dave Alves, he came to us from Bealls ’ls. He worked at Bealls, he worked at TJX. And so he has a really good knowledge about the department stores, the off-price business. He's running stores for us. So he spent a lot of time doing that as well. So he's going to bring a lot, he already has. I mean, both of them have been in the company for 3 to 4 months now, but they're already making an impact in the organization. So I feel very good about the current team and the new people that we've brought on Board.

Switching gears, a margin question, Jill, to bring you into it here. Company is guiding to about 4% EBIT margins this year. You have a long-term goal for 7% to 8%. What's different about the margin structure today versus 2019 when you were operating near 6%? And maybe talk us through the bridge to that 7% to 8%.

Sure. First, I want to say, we have extreme confidence in achieving the 7% to 8% over the long-term. I think today, if you look at our guidance, our margin is already at 36% to 36.5%, which is right in the sweet spot of what we had given in our guidance. What it really comes down to is driving a small amount of top line growth. So we need about 1 point to 2 points of comp. We get a tremendous amount of leverage off of our SG&A to do that. So everything you're hearing from Tom today when coming to Sephora, a lot of white spaces that we aren't participating in today to drive that top line is really the trigger in which we will get to the 7% to 8%. I think we manage expenses quite disciplined. We have a great cost culture, but there's just a normal amount of fixed cost when you're in a negative comp position. We run a variable cost model on our store payroll, which is our number one SG&A cost. But regardless if you're doing $1 sale or $1 million of sale, you still have to have at least 1 person they are checking someone out, you have someone there to put the goods on the floor. So we get to a fixed component to that structure. Once we start growth and we run the variable model, it works incredibly well. So I would say we need to get that 1 point to 2 points of comp lift. And I think a lot of the things you're going to hear from us today is really focused on driving top line, and then that will drive the 7% to 8% operating margin.

And then inventory, I don't know if this is for Tom or for Jill, maybe you're going to fight over this, but inventory management, I know another key priority for the company. Talk about the opportunity you have here, and how you expect the year to unfold from an inventory perspective?

Can I take this one, please?

We have -- both have a strong amount of passion on inventory.

It's -- we both have a passion for it because it's so important to control your inventories. 2022, Kohl's went through some really, really tough times because of the high level of inventory that we had in the company. We finished the second quarter with 48% more inventory than the prior year. Then we got it down to like 36% over. And at the end of the fourth quarter, we got it down to 4% over the prior year. And it just messed everything up. We couldn't react to the business. We had to do a lot of cancellations of product, et cetera. So we got to minus 6% in the first quarter -- at the end of the first quarter, excuse me. And it's one of the few times that we've been able to really discipline as a company, our approach to inventory control. I learned that in off-price. I mean, you look at their turns and whatever they turn pretty fast. And it always was a key component of the strategy overall. So we're going to continue. We're going to continue to operate with a negative mid-single-digit inventory levels for the foreseeable future. And not only are we doing that but we're also leaving open to buy a chase product when it works, okay? Before we didn't -- we didn't have that ability because we didn't have the disciplines in place. So now we have money to spend still in the second quarter. I don't know if we'll spend it yet. We'll see what happens, but we do have a lot in the second half of the year. But we really feel that's one of the key ingredients for our success is to make sure we have the open to buy chase goods, any day of the week. Do you want to add to this?

[indiscernible] plan around even when we're taking our markdowns, it's much more timely. So in the past, we took seasonal marks. We'd take our spring and summer in August, September. We take our winter holiday in February and March, and we're actually taking it much more timely. And by doing that, we're moving goods faster. So it actually opens up the open-to-buy for us to bring in fresh receipts. And also does it require as deep of a discount. You're taking a markdown on short in June and July. You don't have to go as deep as if you were going to wait till August or September because it's much more relevant selling. So I think just getting in a normal cadence of taking those markdowns and then opening up yourself for fresh receipts coming in is really impactful to the turn as well. So I think part of -- if I go back to the operating margin question, we talked about getting to a 4x churn. We did a 4x churn in 2021, and we ran an [ 8% to 6% ] operating margin. So I think it's a key enabler to unlocking that as well.

Okay. Okay. Sticking with the balance sheet theme for a moment. Current leverage ratio is close to 5x adjusted debt to EBITDAR. 2.5x is your target over time. What does the path look like to get back to that level?

Sure. So I think first, as Tom mentioned, we came into ending last year we had a lot of inventory and we took a onetime action. And that action is something that's not going to be repeatable based on everything you've heard us outline thus far today. If you take that Q4 number out and you put in a normal Q4, you actually come down to like 3.5% or a little over 3.5%. So part of it is being really penalized through one of the actions that we took that got us in a really fresh inventory position that is going to carry us through for the foreseeable future. I think second is we are deleveraging on the debt side of things. So we did take out $164 million of debt in Q1. There's another $111 million that we'll take out at the end of the year. So we'll move down about $275 million from a debt perspective. And then obviously, very focused on continuing to drive on the EBIT side of the business. Our CapEx is down. We're going to $600 million to $650 million. The bulk of that is really in the Sephora shops that Tom had mentioned. So a strong ROI project. But historically, we've been closer to that $700 million to $800 million. We're still committed to the dividend. I know it's at a high yield, but our job here is to make the yield go down only because the stock price is going up. So we're focused on that. So we will pay out the $2 dividend. I mean we won't be doing new share buybacks until we get back to our normal cash flow generation. We will see operating cash flow generation starting in Q2. We'll be working down our revolver and be out of that by the end of the year. So I think we're taking some really good steps in that perspective. And then going back to inventory that just opens up a lot of working capital, which is really how that cash generation continues to pay forward.

Great. Tom, what are the -- what elements other than the faster inventory turns, what other elements of the off-price playbook do you see as most relevant to Kohl's?

I think I've mentioned a lot of them already. And Jill just mentioned one of them, I think how they take markdowns, and we want to replicate what they're doing, taking markdowns when things aren't selling. I mean that seems like [ 101 ], doesn't it? But we weren't really doing that. So we're going to have -- we're going to allocate permanent markdowns every single month, so we can address tough sellers versus waiting to the very end of the season to take the markdowns. I talked about the chase. I mean, that's all about -- that's off-price in general. Having a strong home decor business. I mean, if you look at some of the off-price players, you'll see that they have very strong home decor, learned a lot from [ Matt ]. More disposable type of home decor. And it would -- it's going to attract the younger consumer as well as we get into that kind of product. But I think we hit most of the things. Kohl's isn't going to be an off-price retailer. We have our roots in terms of what we want to do. We have these great brand relationships with the key brands in America. And we want to preserve that. And we just want to make sure that we are continuously adding value, which is another off-price tenant. And we're sending the buyers out every single week to go and look for things that we can add value to the selling floor.

Sticking with the product theme, apparel has long lead times, making changes to product strategies can often take multiple seasons. What does the road map look like for Kohl's?

Well, we expect to make progress with that. We've already made progress. We're going to continue to make progress as we get through -- go through the year overall. And wherever we can make it, make progress. I mean, having open-to-buy can help us with that, help us get into the things that we need to quicker. But I see a nice progression throughout the year. And then '24, you'll see even more and we'll be in better shape. I've been on the job for about 3 or 4 months now. So -- but we're working on all the things that we need to.

And you touched on Sephora a bit earlier. It's been a really nice positive for Kohl's. Q1, I think, you discussed 150% growth in beauty, mid-teens comps in those original 200 shops. It's been a driver to customer acquisition. I was hoping you could touch on that a little bit. And also, I often get asked, how do you get that new Sephora shopper across the aisle and shop in other categories?

Sure. So I'll start with some Sephora. So we are seeing a younger more diverse customer. We're actually seeing the Southern market outperformed so bringing in some new customers from that perspective. I think we used to say that 25% of all the customers renew, were announcing30% of all of those customers shopping Sephora new. So as we continue to expand, we continue to see that customer coming in and shopping. It's the only replenishable item we really have in our stores. So we're taking advantage of that traffic pattern. And I really like it in a lot to when you opened a new store, you saw that comp store growth in years 2, 3, 4, and we started seeing that with the mid-teen growth in those first 200 stores that we opened back in 2021. So we are really excited about what we're seeing from a Sephora perspective. 50% of those customers are buying something else. And I think that's where the opportunity is to continue to increase the amount of cross-shopping from that customer, particularly bringing home to the front when we're taking out the registers, they'll be agreed to with something that's much more of an impulse buy. It will be an opening price point. So it won't be something that will break the bank, but they'll be greeted with that versus registers. So that will encourage them to buy something. Really focusing on women's. I mean we had a lot of active, which is something we're still excited about. Our active apparel did run a positive comp in Q1, but really bringing forward like more dresses and understanding that she also wants more of that polished casual look so we can get her across the aisle there. Interestingly enough, we see them even buying things such as our big ones. So we know that they'll mix the high AUR item from Sephora with an opening price point brand in our home goods as well. So how can we take advantage of more from that perspective? And I think last is value. So this is not a customer that knows Kohl's. So as we look at simplifying our value and not being so reliant on coupons because this customer may not be coming in with the coupon. So we're looking at the ticket price, they may not see how great the value is because they don't have all the pieces of the pie. So as we continue to simplify value and really stand more for price, we think that will resonate with that shopper as well.

So having a strong beauty business is key also. I mean, Kohl's never really did well in the beauty business. And having this relationship now with Sephora is really key. We really feel it's going to be instrumental in building our women's apparel business, as Jill said. Our women shoe business, women's accessory business. There's so many benefits that come with the Sephora in Kohl's now. But we think that every single year, we're just going to continue to have new customers coming in because obviously, as we roll it out, then people know and it's communicated and we do our marketing correctly. And we're going to definitely bring in new customers, which is something very important to Kohl's, that are younger and more diverse.

To follow up on the point on pricing and promotions and your efforts to simplify there. In Q1, Kohl's did test some changes to promotions. E-commerce ended up falling a bit more than expected. It was down 20%. Stores were up. But I guess what is the takeaway here in terms of the price sensitivity of the Kohl's consumer? And how does that inform your tests moving forward and your pricing strategies moving forward?

Well, the one thing we really focused on is, we had a lot of layered events where take 20% off, then take another 20%, then you get Kohl's Cash, et cetera. I mean it was so intense. The customer didn't even understand it. So we want to move from these general public offerings so that you're not promoting everything in the company. And you're discounting something that might be selling at 50% a week as well as something selling 3%, all at the same discount. What we want to do is we want to move into more targeted offerings. Having events that are based on things that we decide we want to promote at any given time. So -- and it's working. And we've spent more markdown dollars on clearing product, marking product down, as I mentioned before. So they're still going to get great discounts. That's not -- we're not going to do a radical change and get rid of everything, and we know how that worked out. That was done before. But -- with another company. So we're not going to do that. We're going to do it very carefully, very measured. And -- but we're getting rid of some of these layered events, especially we had online-only promotions in Digital. And we're an omni company. We want to have the same events in every single channel. And the other thing we're doing is we're really beginning with back-to-school. We're bringing in some key value items where the goods are priced to sell well. Every single day, again, small -- again, it's going to be measured. We're not going to do anything radical. But if this works, we really believe that we can roll it out throughout the company at a quicker pace. And that in turn will help us in turnover and other things. Do you want to have anything to add on that?

No, I think the -- well, we're doing that balancing out with the fact that we have a customer who is used to coupon. So that's why we're doing a receptor-based approach. So they're not going away. They're just going to be simplified. And I think pricing transparency, you mentioned Digital. It's so important on Digital. So this actually affords us the opportunity to be even more competitive just on price versus making people net things down. So although it did have a little bit of an outsized impact in digital, we did see a huge benefit to our stores. And so we expect digital continue to have a little bit of weight from that, but the positivity in stores is really what we're looking for.

Okay. Great. And we only have a minute or so left here. But maybe in closing, it would be great to just hear your high-level views on the health of the consumer and how do your macro views, I guess, impact the agenda here in the near-term?

Well, I think the middle income customers being squeezed, it really started back in 2022. And there's a lot of uncertainty in terms of what's going to happen as we progress through the year. But we really feel we have so many opportunities. I mentioned the Sephora many times. And the home business improving our assortments in women's -- in the women's business, delivering -- continue to deliver a lot of value. So we think we can offset if there's any kind of issues with the initiatives we have put in place going forward.

Wonderful. Well, I think we can leave it there. Thank you so much for making time to join Baird's conference. And everyone, please join me in thanking Tom and Jill for a great presentation.

Thanks, everybody.