By Callum Turcan
In this note, we cover one quality retailer and two retailers that were facing a myriad of problems long before the novel coronavirus (‘COVID-19’) epidemic reared its head.
Best Buy
One of the few retailers out there that has actually been able to mitigate the threats posed by e-commerce giant Amazon Inc (AMZN) is Best Buy Co. Inc. (BBY), and as of this writing, shares of BBY yield a decent ~2.8% on a forward-looking basis.
On February 27, Best Buy reported fourth quarter and full-year earnings for fiscal 2020 (period ended February 1, 2020) that beat consensus estimates on both the top- and bottom-lines. ‘Enterprise comparable sales’ growth in the fourth quarter (includes both domestic and international operations) also beat consensus estimates, and for the full fiscal year, Best Buy’s enterprise comparable sales were up 2.1%. This strong performance played a key role in Best Buy recently pushing through a 10% sequential increase in its quarterly dividend (on an annualized basis, Best Buy’s dividend now sits at $2.20 per share).
Looking ahead, Best Buy is guiding for flat to 2% growth in its enterprise comparable sales in fiscal 2021 while its revenues are expected to grow marginally at the midpoint of guidance. Please note this guidance factors in the expected impact of the ongoing COVID-19 epidemic, to the best of management’s ability at the time of the announcement. However, Best Buy factored in a short-term disruption, not a long-term one. In fiscal 2020, Best Buy reported non-GAAP diluted EPS of $6.07 and management expects that will grow to $6.10-$6.30 in fiscal 2020. Furthermore, Best Buy exited fiscal 2020 with a net cash position of $1.0 billion (inclusive of negligible short-term debt) which we really appreciate.
In fiscal 2020, Best Buy generated $1.8 billion in free cash flow and spent $0.5 billion covering its dividend obligations along with $1.0 billion repurchasing its stock. We rate Best Buy’s Dividend Growth trajectory as EXCELLENT due to its strong financial and operational performance, and due to its Dividend Cushion ratio sitting at a nice 2.5x. Best Buy’s GOOD Dividend Safety rating sits right near the threshold for an EXCELLENT Dividend Safety rating, which we also appreciate.
Shares of Best Buy, as of this writing, are trading just below our fair value estimate of $80 per share after the recent selloff and among all of the retailers out there, this is one of the better companies in terms of financial and operational performance. Times are going to get tougher as the firm now must navigate the pitfalls posed by the ongoing COVID-19 epidemic, and that’s a task made much easier through its net cash position.
Kohl’s
Kohl’s Corporation (KSS) reported fourth quarter and full-year earnings for its fiscal 2019 (period ended February 1, 2020) that saw its top- and bottom-line performance beat consensus estimates. However, weak forward guidance saw shares of KSS trend lower since then as of this writing. Management expects Kohl’s will post comparable store sales growth of -1% (negative 1%) to 1%, or flat at the midpoint of that guidance, in fiscal 2020. Given the benign economic backdrop and the fact that this guidance doesn’t reflect the potential impact the ongoing COVID-19 epidemic could have on consumer spending, investors were underwhelmed. Please note Kohl’s comparable sales were down 1.3% year-over-year in fiscal 2019, highlighting its weakening performance.
Additionally, Kohl’s is guiding for its gross margin to weaken by 10 to 20 basis points this fiscal year versus fiscal 2019 levels. Weakening gross margins don’t bode well for a major retailer. Management expects Kohl’s will post (on a non-GAAP adjusted basis) $4.20-$4.60 in diluted EPS in fiscal 2020. On a non-GAAP basis, Kohl’s posted $4.86 in diluted EPS in fiscal 2019 which in turn was down from $5.60 in fiscal 2018. It’s clear that Kohl’s financial performance is trending towards the downside, and that’s reflected in the weak share price performance of KSS over the past year.
Kohl’s intends on repurchasing $0.3 billion to $0.4 billion of its stock in fiscal 2020, keeping in mind the firm exited fiscal 2019 with a net debt load of ~$1.3 billion (inclusive of short-term debt defined as ‘finance leases and financing obligations’). We would prefer that Kohl’s reduce its net debt load given its weak performance during times of strong consumer spending in the US. While shares of KSS are trading near the bottom end of our fair value estimate range (which sits at $36 per share) as of this writing, we view the market as appropriately factoring in the retailer’s lackluster outlook, indicating shares are likely trading near their fair value at this time. Thusly, deleveraging would be the prudent move, in our view. Kohl’s generated $0.8 billion in free cash flow in fiscal 2019 and spent $0.4 billion covering its dividend obligations and another $0.5 billion on share buybacks.
As of this writing, shares of KSS yield ~7.8% and the firm carries a POOR Dividend Safety rating given its Dividend Cushion ratio stands at 0.8x, which could improve if management were to pursue material deleveraging activities. We rate Kohl’s Dividend Growth trajectory as VERY POOR given the firm’s various problems, which doesn’t leave room for sustainable per share payout growth.
Macy’s
On February 25, Macy’s Inc (M) reported fourth quarter and full-year earnings for fiscal 2019 (period ended February 1, 2020) that saw its adjusted (non-GAAP) diluted EPS beat consensus estimates and its GAAP revenues beat consensus estimates. However, shares of M still tanked after the report and we view the firm’s ~12.2% yield (as of this writing) as screaming that Macy’s dividend could be in danger, and its low P/E, despite the stock trading lower than our fair value estimate at this time, indicates a potential value trap. Macy’s exited fiscal 2019 with $3.5 billion in net debt (inclusive of short-term debt). In fiscal 2019, Macy’s generated $0.7 billion in free cash flow which fully covered $0.5 billion in dividend obligations (share repurchases were negligible during this period).
However, Macy’s deteriorating financial performance paints a dour picture going forward. Its GAAP revenues in fiscal 2019 declined by almost 2% year-over-year and Macy’s GAAP gross margin deteriorated as its cost of sales grew to 61.8% of its net sales (this excludes net credit card revenues, which were flat year-over-year) from 60.9% of its net sales in fiscal 2018. Operating expenses also grew as a percent of net sales, highlighting the various pressures Macy’s is contending with. Looking ahead, Macy’s is guiding for $23.6 billion to $23.9 billion in sales in fiscal 2020, down over 3% year-over-year at the midpoint of guidance. Furthermore, this guidance does not factor in the potential negatives posed by the ongoing COVID-19 epidemic.
Looking ahead, we view Macy’s future free cash flows as coming under fire regardless of whether or not the US economy avoids a recession over the next 12-24 months. Macy’s comparable store sales fell in fiscal 2019 by almost 1% year-over-year (0.8% on an ‘owned’ basis and 0.7% on an ‘owned plus licensed’ basis) and if that’s the kind of performance Macy’s is putting up during times of strong consumer spending in the US, imagine how poorly the firm would perform should US economic growth slow down. When the yield on a firm’s stock jumps over 10%, while some analysts might think that’s a great opportunity given the very low interest rate environment we are currently facing, that usually is a huge red flag. We rate Macy’s Dividend Safety as VERY POOR due to its -0.1x (negative 0.1x) Dividend Cushion ratio.
Avoiding value traps, and the capital depreciation that often follows, plays a key role in generating alpha. We encourage our members who have not read our book Value Trap to consider picking up a copy today (link here). In our view, there’s a good chance that Macy’s will be forced to cut its per share dividend payout in the medium-term.
Concluding Thoughts
Amongst the three retailers covered in this note, it’s clear Best Buy has found a way to prevent itself from getting crushed by Amazon while Kohl’s has actually teamed up with the tech/e-commerce giant as part of its ‘Amazon Returns’ program. The medium/long-term outlook for Best Buy looks promising, keeping COVID-19 concerns in mind, while the outlook for Kohl’s and Macy’s will likely continue to deteriorate as their weak performance this late in the business cycle doesn’t bode well for their potential performance in the event US economic growth slows down materially.
One of our favorite names in the retail space remains Dollar General Corporation (DG), a long-time holding in our Best Ideas Newsletter portfolio which has been a big winner so far. Dollar General has a nice growth runway ahead of it with plans to expand its footprint substantially in the US, particularly in areas where Dollar General has a competitive advantage over Amazon (smaller towns and cities). Another retailer we like is Cracker Barrel Old Country Store Inc. (CBRL), which is included in our Dividend Growth Newsletter portfolio, due to its nice dividend growth trajectory (keeping in mind Cracker Barrel also pays out meaningful special dividends as well). While the restaurant space has come under pressure of late, Cracker Barrel has been able to outperform, relatively speaking.
On a final note, we caution our members that the risks posed by the ongoing COVID-19 epidemic remain very real, and sincerely hope that everyone stays safe during this potential pandemic. We will continue to follow this event very closely and intend on updating our members with new and relevant information as it becomes available.
Dollar Store and Department Store Industries – KSS M JWN BIG DG DLTR PSMT
Specialty Retailers Industry – AAN BBBY BBY GME HD LOW LL ODP SHW TSCO WSM
Related: AMZN, CBRL
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Callum Turcan does not own shares in any of the securities mentioned above. Cracker Barrel Old Country Store Inc (CBRL) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Dollar General Corporation (DG) is included in Valuentum’s simulated Best Ideas Newsletter portfolio. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.