Department store operator Kohl’s [NYSE:KSS] is a logical take private candidate as the US economy reopens and value-conscious consumers return to physical retail stores, several industry sources said.
While shoppers flocked to one-stop shop retailers like Target [NYSE:TGT] during the pandemic, there will likely be rebalancing as the vaccine rollout continues in the US, some of the industry sources said. Both retailers carry a variety of apparel and home products, but Target also sells food and beverages, which saw substantial growth during the pandemic.
COVID-19 conditions highlighted the continuing challenge of e-commerce competition, but Kohl’s still serves a loyal and value-conscious customer base, a sector investor added.
Kohl’s shares have been down since a high of close to USD 82 in 2018, dropping to as low as USD 11.51 in early April 2020 at the onset of the pandemic. Over the past five years, Kohl’s stock has underperformed discount retailer peers like Ross Stores [NASDAQ:ROST] and TJX Companies [NYSE:TJX].
Last October, the Wisconsin-based retailer had announced a long-term strategic plan to drive topline growth and focus on capital management centered around active and casual wear as well as beauty. Shares moved up on the news, and continued climbing in November amid a broader rally for the retail sector on vaccination rollout progress, up over 210% to date. Shares ended the day at USD 60.25.
Yet, the company was caught in the crosshairs of an activist group. Macellum Advisors, Ancora Holdings, Legion Partners Asset Management and 4010 Capital, collectively hold a 9.3% stake in Kohl’s including options. On 22 February, the activist group issued an open letter criticizing the company's existing strategy, noting eroding margins and stagnant sales.
Following engagement, the retailer settled with the activists in April, adding three board members and expanding its share buyback program. Kohl’s shares have been up about 14% since the campaign became public in February.
As part of its pitch to unlock value, the activists pushed Kohl’s to implement a suite of operational changes and explore a sale leaseback transaction, estimating that non-core assets could be worth as much as USD 8bn.
Potential suitors of the over USD 14bn enterprise value company could look to finance a buyout using the retailer’s real estate assets, some sources said. Kohl’s operates over 1,000 stores and owns over 400 of them.
Financial sponsors embracing retail
There have been signs of buyer interest in retail with loosening of social distancing policies in sight in the US.
This month, Hellman & Friedman announced it was proposing to acquire home goods retailer At Home Group [NYSE:HOME] for USD 2.8bn enterprise value deal, valuing the company at around 8x adjusted EBITDA multiple.
In March, Apollo Global Management announced plans to acquire The Michaels Companies, a specialty provider of arts, crafts and seasonal merchandise, in USD 5bn enterprise value deal that valued the company at about 6x adjusted EBITDA. Both retailers reported growth during the pandemic period.
Meanwhile, L Brands [NYSE:LB] in April announced that it would spin off its Victoria’s Secret business after reportedly re-engaging with suitors earlier this year, angling for a much higher valuation than an agreement struck last year to sell a majority stake to Sycamore for USD 525m. The Sycamore deal was later terminated.
Victoria's Secret saw sales decline close to 28% during the pandemic, bringing in USD 5.4bn last year. Sales for 1Q21 came in at around USD 1.6bn, up over 70% from the same period in 2020, but still 7% below 2019 first quarter sales figures.
Net sales for Kohl’s declined 20% in 2020 to around USD 15bn. However, sales are expected to rebound as the economy strengthens and stores like Kohl’s see an increase in consumer foot traffic, one of the sector advisors said.
Financial sponsor Sycamore Partners could be among logical suitors of Kohl’s given its experience in the retail sector. The sponsor could see substantial synergies in combining Kohl’s operations with other retail assets in its portfolio like Belk, which it acquired for USD 3bn in 2015, some of the sources said.
The North Carolina-based retailer emerged from chapter 11 bankruptcy earlier this year. Two sector advisors said a combination of Belk and Kohl’s could help in extracting sourcing synergies as well as cost synergies through closing of geographically overlapping stores.
They said monetization of the real estate assets could help potential suitors cough up the hefty equity check for Kohl’s, which is likely to be at least north of USD 5-6bn. They noted a take-private of a retailer like Kohl’s could support 4-4.5x EBITDA leverage at best.
The company trades at 8x estimated forward EBITDA.
One of the advisors said Kohl’s generates a meaningful amount of cash and by monetizing its stores, a strong case can be made for a leveraged buyout as financial sponsors look to put more capital to work. He and another advisor, however, cautioned that a lot will depend on how levered Kohl’s balance sheet would be as it transitions to leasing fully its stores.
Kohl’s has a BBB- rating with a stable outlook based on better than expected operating results, according S&P Global Ratings, which expects Kohl’s to achieve leverage in the low 2x area this year.
As of 4Q20, the company has USD 6.7bn in total debt with a 7.59x adjusted debt to adjusted EBIDTAR ratio, according to company filings.
While some retailers like Target own many of its stores, discount competitors such as TJX have focused more on a leasing-heavy strategy, the sector investor noted.
In addition to supporting a sale, sale leasebacks can also help retailers fund future expansion projects, said Stan Johnson Company associate director Jeff Tracy.
Kohl’s has suggested that a sale leaseback proposed by activists could hurt its investment-grade credit rating.
The impact on the company’s credit rating would depend on how it chooses to allocate proceeds from any deal, said S&P analyst Helena Song.
Last year, the retailer sold two warehouse facilities for USD 195m.
As the future of offices and physical storefronts remain in flux, investors have “flocked” to more stable industrial real estate assets that could bene t from e-commerce tailwinds, Tracy said.
Still, one former Kohl’s investor noted that the activist investor group’s sale leaseback and buyback push is unlikely to excite public market investors over the long-term. Investors are looking for the company to demonstrate substantial growth potential, the former investor said.
Kohl’s financial performance has been relatively flat over the years, generating USD 18.9bn in net sales in 2019 compared to USD 18.6bn in 2016. Meanwhile, adjusted operating margins declined from 7% in 2016 to 6.1% in 2019.
Still, Morningstar analyst David Swartz and the former Kohl’s investor agreed that it’s questionable whether the activists have a better plan than incumbent management to bolster results.
CEO Michelle Gass has worked to bring more customers in stores with initiatives like its partnership with makeup retailer Sephora and its Amazon returns program, but it remains unclear how many of those customers will ultimately make purchases at Kohl’s going forward, the former investor said.
The company reports earnings tomorrow.
Kohl's did not respond to requests for comment.