This cheap stock just got 12% cheaper

Stock market valuations hit multi-year highs in 2021, helping the S&P 500 hit a record high last month. Nevertheless, the shares of Kohl’s (NYSE: KSS) recently traded at a low valuation of less than 10 times forward earnings.

Kohl’s shares got even cheaper last week, falling 12% to end the week at $ 48.56: 25% below their 52-week high. This pullback represents an excellent buying opportunity for long-term investors.

Kohl’s market performance, data from YCharts.

Why Kohl’s stock suddenly took a dip

A major downgrade by analysts and a weak earnings report from Bed bath and beyond (NASDAQ: BBBY) causes Kohl’s shares to fall 12% on Thursday alone.

Bank of America analyst Lorraine Hutchinson downgraded her rating on Kohl’s by two notches, from buying to underperforming. During that time, she lowered her price target from $ 75 to $ 48. Hutchinson noted that supply chain disruptions continue to worsen, particularly in the sportswear category. This could make it difficult for Kohl’s to get enough inventory to increase sales. She expects the problems to continue into 2022.

Bed Bath & Beyond’s terrible second quarter earnings report appears to corroborate Hutchinson’s concerns. Comparable sales were down 1% year-on-year, missing management’s modest growth expectations, due to a marked slowdown in store traffic in August. Additionally, skyrocketing freight costs caused the adjusted gross margin to fall below the company’s forecast at 34%.

As a result, Bed Bath & Beyond’s adjusted earnings per share plunged 92% year-over-year to just $ 0.04. On average, analysts expected EPS of $ 0.52. Finally, management warned that the headwinds that plagued Bed Bath & Beyond in the last quarter continued into the third quarter.

Bed Bath & Beyond is a bad comparison

Investors appear to be overreacting to the weak results of Bed Bath & Beyond by shedding other retail stocks. Bed Bath & Beyond has struggled with stagnant sales and declining margins for years. In fiscal 2019 – before the pandemic hit – adjusted net income totaled just $ 57 million, up from a peak of $ 1 billion in fiscal 2013.

BBBY Net Income Chart (TTM)

Bed Bath & Beyond (TTM) net income, data from YCharts. TTM = 12 rolling months.

Kohl’s profitability also deteriorated over the same period, but not to about the same extent. And while Bed Bath & Beyond is closing hundreds of stores due to underperformance, Kohl’s has only closed a handful of stores and says 90% of its stores generate more than $ 1 million in cash flow. of cash per year.

Additionally, while sales of Bed Bath & Beyond’s main banners fell 12% in the last quarter compared to the same period in 2019, Kohl’s reported in August that total revenue increased slightly from 2019 in its second fiscal quarter. Equally important, while Bed Bath & Beyond posted a pitiful adjusted operating margin of 1% in the last quarter, Kohl’s posted an exceptional operating margin of 12.8% in the second quarter, with gross margin reaching 42. 5%: up 3.7 percentage points compared to 2019.

To be fair, Kohl’s fiscal second quarter ended on July 31, while Bed Bath & Beyond’s second quarter ended four weeks later. Slowing in-store traffic and skyrocketing freight costs last month partly explain Bed Bath & Beyond’s underperformance. Yet even on an apple-to-apple basis, Kohl’s clearly sees significantly better sales and profit trends than the furniture chain.

The exterior of a Kohl's store.

Image source: Kohl’s.

Focus on the long term

Hutchinson (the Bank of America analyst) may be correct that supply chain issues will disrupt Kohl’s sales growth and weigh on its profits in the second half of this year and at least part of it. ‘fiscal year 2022. However, that does not mean that investors should sell Kohl’s stock.

The current supply chain challenges will ease sooner or later: probably sometime in 2022. In addition, Kohl’s recently started opening Sephora Beauty Salons in some of its stores. This new partnership is expected to result in a sharp increase in traffic and in-store sales as Kohl’s continues to roll out Sephora over the next two years.

Selling Kohl’s shares when they are trading at less than 10 times earnings and earnings are expected to improve significantly by 2023 doesn’t make sense. In addition, Kohl’s has at least $ 1 billion in excess cash and continues to generate strong free cash flow, which will allow it to capitalize on stock price declines by accelerating share buybacks. On the contrary, Kohl’s long-term investment record looks better than ever after the stock’s recent pullback.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

Lee J. Murillo

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