Chapter 10 - Wall Street's Early Love Affair

Since its initial public offering in 1992, Kohl’s has grown at a compounded annual rate of over 20%, making it one of the fastest growing retailers in the past 15 years.

And even with the dismal performance of the stock in the last several years, it has been one of the best performing retailing stocks trading since 1994. The stock has had three stock splits, in the Aprils of 1996, 1998 and 2000, an unprecedented run for a retail stocking trading on the NYSE. Someone who say invested $10,000 in the 1992 IPO would have seen their investment zoom up to a value of $640,000 a decade later!

Wall Street was so enthralled that Kohl’s stock was often traded at extremely P/E ratios, reaching into the 70s in mid 2000. Despite the dilution created through the periodic but regular issuance of new stock to help fuel the opening of new stores, analysts on Wall Street generally rewarded the stellar performance of the company with high P/E ratios. Analysts like Shari Schwartzman Eberts at JP Morgan issued glowing reports in 1999 about the “Next Generation of Department Store” as it rolled out it’s “hybrid” concept across the United States.

And for those analysts who remained cautious throughout the 1990’s, skeptical about the company’s ability to maintain growth, they missed the upside of one of the best –performing stocks on the S & P 500. For them, Kohl’s kind of lofty p/e ratios were, as some would say at the time, “nosebleed territory,” and they chose to advise their clients to avoid the stock or, perhaps, buy on weakness. Essentially, they missed the boat.

(Editor’s note: That was then and this is now. When the ‘stall’ of Kohl’s began in 2002-2003, the P/E has seen a generally steady decline: first declining to the 50’s, then 40’s, then 30’s, and in the last couple of years in the high teens and low 20’s. And, unfortunately, from 2003-2007 Kohl’s stock has grossly underperformed compared to the S & P 500).

Let’s return to the original business model: by any measure, it has provided historical numbers that became the envy of the retail industry.

The key metrics or gauges of performance that I am about to outline show a consistency that was unparalleled among major retailers in the United States during the time period of 1992-2002:

1.NET SALES - At the time of the IPO in 1992, Kohl’s management announced a goal of increasing sales 20% a year. This was to be accomplished by adding new stores over time, but also through comparable store sales of between 3-5%. It was a cornerstone of the business model.

For the next ten years following Kohl’s IPO, the company’s compounded annual growth rate (CAGR) exceeded 25%, an incredible achievement.

2. OPERATING & NET INCOME - Perhaps one of the most impressive lines on Kohl’s financial statement has been the selling, general & administrative expenses line. The stores generally manage expenses quite well as a relation to sales, so that even during times when the top-line might be lower than internal expectations, the stores knew how to ‘pull it back’ and come in with a nice selling cost. But additionally, the company has been able to leverage its growth by improvements at the distribution centers, belt tightening at the corporate office and continual customer loyalty with proprietary credit operations.

For the ten years following Kohl’s IPO, the company’s CAGR for operating income exceeded 27%, indicating good leverage. The CAGR for net income is even better, exceeding 30% over this time period.

3. COMPARABLE STORE GROWTH – Always viewed as the prime metric for the performance of a retail entity, Kohl’s excelled at maintaining incredible consistency in comparable store growth over an extended period of time. Below is a chart showing an incredible feat over the years 1997-2002:

Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Year 1997 5.3 11.5 9.5 5.0 14.1 12.1 17.5 1.5 14.4 6.8 11.7 10.3 10.0 1998 10.3 12.5 11.5 17.2 4.9 10.4 3.3 5.8 3.7 3.2 6.7 11.9 7.9 1999 11.2 18.0 1.8 3.7 15.0 6.7 7.7 6.9 6.2 5.3 7.8 8.5 7.9 2000 5.6 6.8 8.4 9.8 5.0 6.7 9.1 9.8 9.5 11.2 14.8 7.1 9.0 2001 7.3 (1.9) 12.7 2.1 1.7

14.4 9.0 5.0 10.7

5.5 5.3

4. NUMBER OF STORES & SQUARE FOOTAGE – A book on the success of Kohl’s would not be complete without an acknowledgement of the impressive addition of new stores and distribution centers in both new and existing markets to help fuel the fast-growth story. When I left Kohl’s in April, 2000, there were 298 stores in 25 states, and three distribution centers. By the end of 2007, there are now over 900 stores in 47 states, and ten distribution centers.

Certainly another aspect of Kohl’s performance that made Wall Street swoon has been the consistency of Kohl’s earnings exceeding projections. Under the cool management of former CFO and then COO Arlene Meier, the company was exceptional in managing analysts expectations and delivered consistent results, quarter after quarter. While many lament this practice of companies trying to meet analyst ‘targets’ within a penny based on earlier guidance, and therefore become pre-occupied with short-term success, this consistency had become the cornerstone, in my mind, as to why Wall Street had been able to justify buying and owning stock as such a high price-to-earnings ratio in the late 1990’s and up until around 2002.

As to how retired Kohl’s CFO Arlene Meier managed to exceed the First Call Quarterly Average Estimate by a penny for often years at a time, what can I say? She was very adept at directing guidance upward, or at times even slightly downward without causing a stir, and that the Kohl’s business was so consistently good over those years that it gave her some flexibility that companies that struggle never have. The old saying, “great sales cure all lot of ills” certainly applies to managing earnings quarter-to-quarter.

And during those high-growth years where we consistently put big numbers on the board, Wall Street loved it.