Kohl's & Macy's Fall Despite Upbeat Q2 Earnings: Here's Why

Last week, retail majors Kohl’s Corporation (NYSE:KSS) and Macy’s Inc. (NYSE:M) reported their quarterly results wherein both delivered better-than-expected earnings and revenues. Despite delivering upbeat results, both companies’ shares tanked, as they are still struggling with industry specific headwinds.

Let’s delve into the details.

Better-Than-Expected Quarterly Results

On Aug 10, both Kohl’s Corp. and Macy’s posted second-quarter fiscal 2017 results.

Kohl’s reported adjusted earnings of $1.24 per share, beating the Zacks Consensus Estimate by 4.2% and prior-year quarter earnings by 2% owing to improved sales in all lines of business, strong inventory and expense management. Net sales of $4.144 billion marginally beat the Zacks Consensus Estimate of $4.138 billion. However, it dipped 0.9% from the prior-year quarter due to a challenging sales environment and lower comparable store sales (comps).

On the other hand, Macy’s posted adjusted earnings of 48 cents a share that topped the Zacks Consensus Estimate of 45 cents but declined substantially from 54 cents reported in the year-ago period. Total sales of this Cincinnati, OH-based company also came ahead of the estimate after missing the same in the preceding two quarters. However, the company’s top and bottom lines continued to decline year over year.

Comps on an owned-plus-licensed basis dipped 2.5%, while on an owned basis comps fell 2.8%. Gross profit in the quarter declined 6.6% year over year, whereas gross margin contracted 60 basis points to 40.3%. Operating income plunged 18%, while adjusted operating margin shriveled 90 basis points to 5.5% in the quarter.

Improved Comps

We note that these companies have delivered lower comps in the second quarter, but the decline was narrower than expected. While Kohl’s posted comps decline of 0.4%, it was narrower than management’s expectation of 1.5% fall, backed by increased traffic momentum and improvement in transactions in the month of July. Macy’s comps declined 2.5%, narrower than the 3.2% fall.

Initiatives Which Boosted Sales

Both Kohl’s and Macy’s are making efforts to strengthen their position in the retail space, amid competitive pressure from both brick-and-mortar discount stores and online retailers, such as Amazon.com, Inc. (NASDAQ:AMZN) .

In an attempt to augment sales, profitability and cash flows, Macy’s has been taking steps such as cost cutting, integration of operations as well as developing its e-Commerce business and Macy’s Backstage off-price business, along with the expansion of Bluemercury and online order fulfillment centers. Moreover, as a part of store rationalization program, the company plans to shut down underperforming stores.

Kohl’s has also been making continuous efforts to improve its base business. Lately, the company has started offering more outside famous brands and cutting down on the number of in-house clothing brands it sells. Kohl’s has started selling Under Armour products, as well as Clarks shoes and is looking for other brands to add to store aisles. The company also plans to continue selling the best-selling of its private-label brands, such as Sonoma, Croft & Barrow and Apt. 9, in order to drive traffic. Kohl’s has also undertaken several initiatives to reduce its inventory to boost profits.

Despite the efforts, shares of both the stocks have been declining over the last few quarters. If we look into the share price performance of these stocks over the last one year, we note that while Kohl’s fell 17.3%, while Macy’s plummeted 50.2%, in comparison to the industry, which declined 40.9%. We believe waning mall traffic and increased online competition has grappled the overall industry and is hurting these stocks.

Both Kohl’s and Macy’s currently carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here. Other than Kohl’s and Macy’s, retailers like J. C. Penney Company, Inc. (NYSE:JCP) and Dillard’s Inc. (NYSE:DDS) also failed to impress investors with their quarterly numbers, pulling down the shares.

Challenges Galore

We note that the retail sector has been witnessing rapid changes of late. Customers now prefer online shopping than buying goods from stores. Thus the e-Commerce business is improving and is acquiring substantial market share of brick-and-mortar stores. This in turn has adversely impacted the store traffic. Retailers are focusing on improving their e-Commerce businesses to tap in on the growing popularity of online shopping. However, by no means are they able to compete with Amazon.com, which dominates the e-Commerce market space.

The retail industry is also facing major challenges from a still-strong U.S. dollar, volatile commodity costs and uncertain economic environment. A strong dollar has resulted in lower spending from foreign tourists and is impacting retailers’ overseas operations. Lower spending on apparel and accessories and a general slowdown in consumer spending are hurting sales at department stores. A highly promotional environment is also forcing retailers to slash prices thus impacting margins negatively.

Bottom Line

Though the companies have reported better-than-expected results, we remain skeptical about the stocks, as the retail chains still have a number of deterrents to overcome. While we are encouraged with the initiatives taken by the companies to grow their sales and market shares, we would still prefer to wait and watch these stocks as retailers will still have to compete against the back-to-school and holiday sales.

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