Consumer retail is home to the most challenging competitive environment of any sector in the economy. Yet companies like Kohl's Corporation (NYSE:KSS) still manage to compete despite having no durable competitive advantages. With larger rivals like Target Corporation (NYSE:TGT) and J.C. Penney treading water -- or worse -- things are looking up for Kohl's.
Able to Compete
Target's revenue is about four times that of Kohl's, yet Kohl's earns higher margins than both Target and J.C. Penney. This means that Kohl's can lower prices below that of Target and J.C. Penney and still earn a profit. This ability to undercut competitors is a key advantage in an industry where price is one of the only effective ways to compete; it keeps Target and J.C. Penney from initiating a price war, which allows Kohl's to earn relatively high margins.
But Target is not doomed just because its margins are lower than its much smaller rival. Target has a much broader portfolio of product offerings that brings its margins down. For instance, it has large exposure to the low-margin food business. But the company's growth initiatives in Canada should increase inventory turnover which will boost the bottom line. However, Target still has to compete with Wal-Mart Stores, Inc. (NYSE:WMT) and The Kroger Co. (NYSE:KR), which it has struggled to do effectively in the past.
J.C. Penney is also in a decent position to succeed. Under the leadership of ex-Apple executive Ron Johnson, the retailer is in the middle of a total corporate transformation. Johnson's new merchandising and store arrangement strategy is resonating with customers and will ultimately pay off for the company and its investors. However, profits are suffering in the short term due to underperformance in many of the company's legacy stores, which will disappear in the next five years.
Lots Going for It
Kohl's has a lot of things going for it. The company has ample opportunity to expand its presence in North America and its merchandising strategy will continue to drive margins upward. The company's refusal to locate the majority of its stores in malls separates it from the competition and has given it a head start as other retailers are discovering that consumers do not like the mall format.
In addition, the company enjoys high returns on assets. Since 2002, the company has averaged a 20% pre-tax return on tangible invested assets. If this average were applied to the company's current tangible invested assets, it would imply 'normal' pre-tax earnings of $2.9 billion. However, the company earned just $1.86 billion in pre-tax income last year, so $2.9 billion seems a little aggressive.