Kohl’s Considering Privatization: Right Call?

Reports have emerged indicating that the department store chain Kohl’s (NYSE:KSS) is likely to take some drastic measures amid concerns over performance due to increased competition from discount stores like Walmart (NYSE:WMT), Costco (NASDAQ:COST) and online retail giant Amazon (NASDAQ:AMZN), among others.

Kohl’s primarily runs its business through a chain of department stores, which sell, among others, private label, national brand apparel, footwear, accessories, beauty and home products. The company also operates an online store at Kohls.com, as well as through mobile devices.

Over the last few quarters, the company has struggled to grow both top and bottom lines. It has only managed to register modest growth rates and it is now considering taking drastic measures to try to handle this problem.

The Wall Street Journal reported last week that some of the options under consideration include the possibility of breaking up the company and privatization. This comes at a time when the company’s stock price is under immense pressure from investors.

Kohl’s stock price is down more than 20% over the last 12 months and has lost nearly 42% of its value since hitting a high of $79 per share in April last year.

Shares of the company are currently valued at 12.33x in P/E ratio compared to the industry average of about 18.46x. Its price-to-sales ratio of 0.48x also compares favorably to the industry average of 1.32x. As such, the company shareholders would be interested to know whether now would be the right time to go private given the low valuation multiples.

If the primary owners of Kohl’s were to take it private, what would be the implications to retail shareholders like you? Obviously, you would have to take your money back, but how much of it would you really put in the bag? Kohl’s appears to be struggling to implement the new business growth model that includes leveraging online business with payments.

Kohl’s became the first company to support Apple Pay for store cards in October, but the benefits of this move are yet to be felt based on performance. On the other hand, Kohl’s credit card users can now shop using the card easily as demonstrated in this short guide while the company battles to save its future by pursuing various courses of action.

Privatization or breakup?

Based on the current valuation multiples when compared to industry averages, perhaps the best way to determine the value of the company before privatization would be based on its growth potential. It is unlikely that the new private owners would be willing to pay for the company’s shares based on industry averages of P/E or P/S. There is a huge gap that they would have to fill in terms of premium based on the current price of the stock.

A recent report by Stifel Nicolaus analysts suggested that a price per share of $95 would be idealfor a leveraged buyout, which would also require debt financing to the tune of $15 billion. This valuation multiple prices the stock at just about 4x its projected sales for the year 2015.

That’s a little bit of a stretch considering the fact that the company would be valued at multiple times to the industry average. It would be a lucrative premium for the current shareholders. But the big question is whether or not the company really deserves such a premium for a leveraged buyout.

When you look at its performance over the last few years, Kohl’s has been struggling to post meaningful revenue and earnings growth.

Since 2013, performance has been mostly flat or downward as demonstrated in the chart below. While the company appears to have created other avenues for revenue generation over the last few quarters, competition from industry giants along with struggling rival Macy’s (NYSE:M) is likely to derail revenue growth in the foreseeable future.

Kohl’s best course of action may yet be separation rather than privatization. Most department chain stores including Macy’s are evaluating the possibility of running their own realty trust company, which would take care of their real estate business.

Just like Macy’s, Kohl’s has several department stores across the U.S. While the company still reports decent revenues, sales have stalled with little or no growth over the last few years. This points to the possibility of a slowing business in some of its stores.

As such, it would be wise to assess which stores are underperforming and prepare them for letting. The company is also working on optimizing its sales model by focusing on national brands rather than private brands while at the same time growing its product lineup in cosmetics and women’s products.

Conclusion

Kohl’s positives emanate from its ability to keep generating revenues and profits. This shows that, despite the increasing competition, the company is able to manage its costs well to keep the bottom line positive.

However, after a lackluster period of little to zero growth on both top and bottom lines, the company is now facing one of the biggest tests in its existence as it considers taking drastic measures to save its stock price. Shares of the company are down more than 40% since April last year; this has made the stock appear particularly cheap in the market based on valuation multiples. While the company continues to face high competitive risk from industry discount stores like Costco and Walmart, it looks as if this may not be enough to ward off the interest of private/activist investors.

As such, Kohl’s must find a solution to its current problems soon, or it may become an acquisition target within the next few quarters.

Originally Posted at GuruFocus

About the author:

Nicholas Kitonyi

Nicholas is a financial analyst by profession with extensive experience in investment research and stock market analysis. His analysis has been featured on some of the leading investment research sites like Seeking Alpha and Benzinga.

Nicholas has a solid knowledge of both the U.S and European markets having done several stock analysis over the last three years. His investment style is focused on undervalued plays and growth stocks. As a trader, Nicholas classifies himself as a swing trader and likes to trade GBP/USD, Gold and FTSE 100, among other liquid instruments.

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