Kohl’s Stock Rebound Faces a Showdown With Short Sellers
The bottom is in for high-yielding Kohl’s (NYSE: KSS), but risk-averse income investors, be warned. After sinking to its lowest levels in early April, the stock has mounted an impressive rebound, yet volatility remains the only thing that should be expected for the rest of the year. While the turnaround is bearing fruit and the recently reduced dividend distribution looks sustainable, uncertainties remain, and the short interest is still a concern.
Although short interest fell 31% sequentially in early August, it remains elevated at about 32% of the float, creating a lingering headwind in Q3 and potentially Q4. That kind of pressure can magnify swings, even as operational improvements support the longer-term outlook.
Short Sellers, Analysts Trends, and Institutional Buyers Drive KSS Volatility
The Q2 earnings release and guidance update sparked a significant rally, with short-covering being a contributing factor. However, the technical action also reveals significant resistance at critical levels that will likely cap gains for the foreseeable future. Those levels align with bearish price action in 2024 and the 2020 COVID-19-induced lows, which is bad news for bulls. This market can move higher, but it will take another catalyst to get above the critical resistance point and on track for a more sustainable rally.
Among the reasons to believe that a more sustainable rally is possible are the institutions. The data provided by MarketBeat reveals that, although they sold on balance in Q1, the group bought at a pace of $2-to-$1 compared to sellers, with buying robust in Q2 and the first half of Q3. This is a significant factor because the group owns nearly 100% of the stock and will squeeze the short sellers out of the market if these trends continue.
The analyst's response to the Q2 release and guidance update suggests that the institutions will indeed remain buyers of this stock. The data tracked by MarketBeat reveals ten revisions, the first in two quarters, and they are all positive, including numerous price target increases and several upgrades. The news is significant because the positive activity ended the downtrend in sentiment, lifted the consensus target by 25% overnight, and helped to put a bottom in the stock price action. The only bad news is that the new targets assume this market is fairly valued below the critical resistance and may not be sufficient to spark a complete market reversal, at least not yet.
Kohl’s Mixed Results: Weak Revenue Offset by Improved Earnings Quality
Kohl’s is not out of the weeds with its revenue contracting by 5.1% YOY compared to growth among its competitors. Worse, the contraction was 200 basis points short of the consensus forecast, driven by a 4.2% decline in comp sales. However, the decline is due in part to increased markdowns and promotional activity that is helping to reduce inventory. Inventory reduction and internal efficiencies combined to drive a better-than-expected bottom-line performance and sufficient cash flow to sustain the balance sheet health while paying the dividend.
The dividend is substantial, yielding about 3.3% in early September. The payout ratio is healthy at 55% following the recent cut and is expected to improve over time. Balance sheet highlights include reduced cash and inventory, current and total assets, offset by reduced current debt and total liabilities. The net result is a 2.6% increase in shareholder equity and persistently low leverage. The company’s long-term debt is running below 0.5x the equity and about 0.5x the inventory, leaving it in a healthy condition, able to continue with its turnaround process.
The next visible catalyst for Kohl’s market is the Q3 earnings release scheduled for late November. The company issued favorable guidance, including an improved outlook for revenue and earnings above the analysts' consensus estimate. Assuming the company can sustain traction with its turnaround, it is likely to outperform its guidance and potentially return to growth before the end of the fiscal year. The off-pride merchandise trends reported by TJX Companies (NYSE: TJX) and Ross Stores (NASDAQ: ROST) are very positive.
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