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Following Dillard's (DDS) weak AprQ report earlier this month, sparked by soft consumer spending, investors were worried Kohl's (KSS) would follow suit. However, KSS swam against the tide, delivering a surprise profit in Q1 (Apr) while topping revenue estimates handily. As a result, shares are breaking out of their downward trend, helping lift the broader retail sector today. This is also being boosted by massive gains from Urban Outfitters (URBN) and Abercrombie & Fitch (ANF) following their impressive AprQ results.

Still, macroeconomic pressure remains, evidenced by KSS maintaining its FY24 (Jan) adjusted earnings outlook of $2.10-2.70 and revenue growth of negative 4-2% yr/yr -- both of which fell short of analyst targets last quarter -- despite its outperformance in Q1. Nonetheless, the company's framework to return to profitable growth outlined in Q4 resulted in tangible benefits, an encouraging development as KSS navigates the obstacle-filled economic landscape.

• In Q1, KSS expanded its adjusted earnings by 18.2% yr/yr to $0.13, assisted by a 67 bp jump in gross margins to 39%. Meanwhile, revs fell 4.8% to $3.57 bln, and comps decreased by -4.3%. KSS's stores business achieved productivity gains in Q1, posting positive low single-digit comp growth, higher in-store traffic, and increased units per transaction, offsetting a lower average ticket from additional clearance actions.
  • Conversely, KSS's digital business did not fare as well due to customers shifting toward in-store shopping and KSS reducing online-only promotions. As a result, digital penetration was 26%, down from 30% last year, although still up meaningfully compared to pre-pandemic levels.
• Sephora (LVMUY) at Kohl's performed nicely in the quarter, igniting total beauty sales growth of 150% yr/yr. The cosmetic industry continues to prove its resilience to unfavorable macroeconomic trends, evidenced by robust Sephora sales, which followed last week's significant outperformance by Ulta Beauty (ULTA) at Target (TGT) in AprQ.
  • On the other hand, KSS continued to experience weaknesses within the home category, a dynamic playing out across a few home furnishing retailers lately, illuminated by negative AprQ comp growth from TJX's (TJX) HomeGoods banner and Williams-Sonoma (WSM).
• Still, due to KSS's updated inventory control processes, inventory was down 6% yr/yr, consistent with its goal of planning inventory down mid-single-digits percent this year.
• Looking toward the remainder of FY24, strengthening its balance sheet is a top priority for KSS. Helping on this front will be continually trimming SG&A expenses, which were down 4% yr/yr in Q1. Management also emphasized the importance of showing incremental improvements from its strategic initiatives, including enhancing its Sephora partnership, simplifying pricing strategies, clearing out excess inventory, and managing expenses.

Following KSS's weak finish to FY23 (Jan), which kicked its profitability framework into gear, we stated that it was best to employ a wait-and-see attitude. After demonstrating healthy progress with its updated framework, we think KSS is positioning itself to reverse its long downward trend. Although macroeconomic challenges still exist, which could create volatility over the near term, KSS is deploying the right strategies to boost sales and improve margins.