Kohl’s logged a surprise steep loss in the fourth quarter and provided EPS guidance for 2023 that was well below analyst expectations as the chain overhauls its merchandise mix to deemphasize active wear in favor of casual and career wear and explore newer opportunities in home and gifting.
The loss in the fourth quarter reflected significant markdowns in the latter part of the period to reduce inventories and accelerate the arrival of new floor sets for 2023.
Shares of Kohl’s were down slightly, off 40 cents to $27.64, Wednesday in late-afternoon trading.
On a call with analysts, Tom Kingsbury, who took over as Kohl’s CEO on February 3, said the merchandise changes reflected a shift to focus on leaner inventories and chase demand to stay on-trend better.
“We need to be more agile in having open to buy, to spend every quarter so that we can chase the business,” said Kingsbury. “It’s better to understand what the customer wants and go after it than to buy it all upfront and hope it sells.”
However, Kingsbury said the initial merchandise change shifted towards more balanced assortments.
“We remain highly committed to the active business supporting our key brands, though we’ll recenter our focus on our customers’ needs by capitalizing on multiple lifestyles,” said Kingsbury. “We will rebalance portions of our assortment to capture our customers’ return to more normal purchasing behavior for their wardrobes. Additionally, we’ll add more offerings across casual and career wear, including, for example, further expanding our women’s dress business following last year’s success.”
Other opportunities include home and gifting, two categories where Kohl’s sees itself as underpenetrated. Kohl’s will also look to build on its recent success in beauty, driven by its partnership with Sephora.
The shift comes as Kohl’s, under its former CEO Michelle Gass, positioned the retailer as the destination for active and casual lifestyles. In October 2020, Kohl’s set a goal to have active categories account for at least 30 of its business, up from 20 percent in 2019. At an Investor Day in March 2022, Kohl’s said the active category had expanded to almost 25 percent of annual revenues, with a boost from the popularity of athleisure and other activewear items during the earlier stages of the pandemic. However, in the fourth quarter of 2022, active, home, and denim were Kohl’s weakest category performers.
Asked by an analyst about potential changes to its active mix, Kingsbury said Kohl’s would be open to following trends across categories.
Kingsbury said, “We’ll let the customer tell us what they want. I think establishing targets in terms of business isn’t in the best interest of our customers overall. So, over time, our mix will evolve to what the customer is looking for. Right now, we feel that the active business is important, but we also feel outdoor is also important. We’re going to integrate into some of the presentations some outdoor products, and we’ve already done that. But I’m not going to set targets in general because we have to be agile. We have to build the assortments relative to what the customer wants, not what targets we set.”
Kingsbury’s arrival as CEO followed the exit of several members of Kohl’s management team amid proxy fights over the last two years by activist shareholder groups. Kingsbury was on Kohl’s board and was formerly Burlington Stores’ president and CEO.
Other new members of Kohl’s team include Dave Alves, formerly at Bealls, as president and COO and Nick Jones, formerly at ASDA/Walmart UK and Marks & Spencer, as chief merchandising and digital officer.
Among the departures, Gass was appointed president of Levi Strauss & Co., while Doug Howe, Kohl’s former chief merchant, joined Designer Brands as president of DSW.
On the call, Kingsbury highlighted four priorities for the retailer in 2023 to drive sales and profitability:
- enhance the customer experience,
- accelerate and simplify value strategies,
- manage inventory and expenses with discipline, and
- strengthen the balance sheet.
On enhancing the customer experience, Kingsbury called out the progress Kohl’s has made with Sephora, as beauty sales jumped 90 percent in the fourth quarter with in-store shops. High-single-digit percent beauty comps came in the 200 Sephora shops that opened in 2021, “better-than-expected” sales were achieved in the 400 shops that opened in 2022 and “strong” digital sales growth in beauty continues. Another 250 2,500-square-foot Sephora shops will open this summer, bringing the total number to more than 850 stores. Fifty smaller Sephora shops are also planned for 2023 to reach all Kohl’s locations by 2025.
Kingsbury detailed the changes to assortments and said Kohl’s is also planning to place a higher focus on improving store productivity. Kingsbury said, “We are rethinking how we merchandise stores to deliver a better experience for customers to drive greater frequency of visits and capture more share of their wallet.”
For example, he noted that gifting assortments in December were moved to the front of the store to capitalize on peak holiday traffic and drive higher sell-through than the prior year. Home and other impulse items will also be featured near the front of the store. Stores represent about 70 percent of Kohl’s sales.
Other growth opportunities online include Kohl’s Marketplace, which will broaden its product offerings, and Kohl’s Media Network, its online advertising platform.
The second priority, “accelerating and simplifying our value strategies,” includes accelerating efforts to reduce reliance on general promotions. Kingsbury said, “We know that our promotional strategy at times can be a disadvantage to Kohl’s compared to our competitors’ price-focused strategies.”
If successful, everyday-value pricing will be tested with a small percentage of product assortments and expanded in subsequent years.
“We fully recognize the sensitivities around pricing with our customers, and we’ll approach this with great measure and flexibility,” said Kingsbury. “A part of this will enhance consistency in our marketing message to improve the customer experience, drive increased customer engagement and make our pricing less complex. When we stand for something with greater clarity and value, our customers do respond; this is evident in the customer response we have experienced in recent weeks related to our clearance effort.”
On improving inventory and expense disciplines, Kingsbury noted that Kohl’s took proactive action during the fourth quarter to clear excess inventory and slow-selling goods. As a result, it ended the year with inventory up year-over-year by 4 percent after seeing inventories end up 48 percent at the end of the second quarter and 34 percent at the end of the third quarter. Inventory is “generally” back in line with sales performance compared to 2019, and inventories at year-end were down 10 percent against the fourth quarter of 2019.
In the future, Kohl’s plans to focus on new receipts and driving turnover. Said Kingsbury, “We will operate so that we have plenty of room to chase receipts, enabling better management of receipt flow. As part of this, we are planning inventory to be down mid-single-digits percent going forward. We will also adjust how we markdown our goods, getting rid of excess inventory or slow-selling items on a more even flow throughout the year instead of waiting until the end of a season.”
Expenses become a higher priority due to the ongoing inflationary environment, with Kohl’s SG&A expense ratio drifting higher in 2022 on lower sales, increased strategic investments and wage inflation. Said Kingsbury, “Growing sales is paramount to easing the expense pressure. However, we must proactively capitalize on other opportunities such as increasing self-service capabilities in our stores, driving improved marketing efficiency and reducing spend across all areas of the company.”
Finally, on strengthening the balance sheet, Kohl’s long-term objective remains to manage the business at 2.5 times debt leverage. In January, Kohl’s replaced and upsized its revolver to a $1.5 billion secured facility, which enhanced its liquidity and flexibility. The focus will be on ending 2023 with no borrowings.
In the fourth quarter ended January 28, sales decreased 7.2 percent year-over-year, to $5.8 billion, slightly below Wall Street’s consensus estimate of $5.98 billion.
Comparable sales were down 6.6 percent. By month, November was down a low-double-digits percent and December down mid-single-digits percent, followed by up high-single-digit percent in January with a positive trend continuing into February. The trends improved as Kohl’s transitioned to a clearance focus.
The decline was primarily driven by reduced traffic, with higher average ticket offsetting lower units per transaction. CFO Jill Timm said on the call, “Our middle-income customers remain pressured and continue to lean into our value-oriented private brands.”
Store sales improved sequentially throughout the quarter and were down 3 percent to last year. The improved performance was driven by having more Sephora shops open and elevated clearance demand late in the quarter, primarily in stores. Digital sales were down 12 percent to last year and accounted for 37 percent of sales.
From a product perspective, sales of private brands were relatively flat in the quarter with a strong performance in top private labels, including Sonoma, Croft & Barrow, Tek Gear, and Lauren Conrad.
Sales of national brands were down a high-single-digit percent, primarily due to weaker active, home and denim performance. Accessories were Kohl’s best-performing category, up mid-single-digits. Strong sales growth in beauty was partially offset by lower sales of jewelry impacted by the removal of fine jewelry counters to make room for Sephora shops.
Men’s and women’s apparel outperformed the company average. Men’s saw solid results in tailored dress, young men’s and outdoor, while women’s came from higher demand for formal casual and dress wear and an improvement in intimates. Juniors continued to be underperformers within women’s and active “challenged across all lines of the business,” said Timms. Home, footwear and children underperformed Kohl’s average.
Gross margins eroded to 23.0 percent from last year’s 33.2 percent. Clearance markdowns contributed approximately 750 basis points to the decline and product cost inflation was approximately 200 basis points.
SG&A expenses declined 0.6 percent to $1.7 billion as reduced spending across marketing and distribution was mostly offset by higher store expenses driven by wages.
The net loss for the quarter was $273 million, or $2.49, well below analysts’ consensus estimate, calling for a profit of 98 cents a share.
For the full year 2022, the net loss came to $19 million, or 15 cents, compared to a net income of $938 million, or $6.32, a year ago and an adjusted net income of $1.1 billion, or $7.33, per diluted share, in the prior year. Net sales decreased 7.1 percent year-over-year, to $17.2 billion, with comparable sales down 6.6 percent.
Looking to 2023, Kohl’s predicted earnings on an adjusted basis, excluding any non-recurring charges in the range of $2.10 to $2.70. Wall Street’s consensus had been $3.20.
Operating margins are expected to reach approximately 4.0 percent, up from 1.4 percent in 2022. Sales for 2023 are expected to decline between 2 percent and 4 percent, including the impact of the 53rd week, which is worth approximately one percent year-over-year.
The guidance assumes EPS will be lower in the first half, with the second half benefiting from easing freight and product cost inflation as well as lapping of the inventory actions taken in the fourth quarter.
“I want to be realistic in setting expectations,” said Kingsbury. “The full impact of our efforts will take some time. It won’t happen overnight.”
Photo courtesy Kohl’s
