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We reaffirm our Neutral recommendation on Kohl’s Corporation (KSS - Analyst Report) following mixed second-quarter fiscal 2013 results. Kohl’s earnings in the second quarter beat the Zacks Consensus Estimate whereas sales missed the same.

Why the Reiteration?

Kohl’s second-quarter earnings of $1.04 per share beat the Zacks Consensus Estimate by a penny in the second quarter. Earnings were within management’s expectation of $1.00 - $1.08 per share and grew 4.0% from the prior-year quarter earnings. The upswing in earnings was due to gross margin improvement and tight expense control, which made up for the soft revenues in the quarter.

Sales increased only 2.0% from the year-ago level to $4.289 billion on the back of positive comparable sales. Sales however missed the Zacks Consensus Estimate of $4.295 billion. Kohl’s posted positive comparable store sales growth of 0.9% in the reported quarter, compared to a decline of 2.7% in the year-ago period. The quarterly increase in comp sales reflects a 4.8% increase in units per transaction that was partially offset by a 3.6% decrease in average unit retail and a 0.3% decline in the number of transactions. E-commerce sales contributed approximately 160 basis points to comps growth.

Gross margin improved 10 basis points to 39.1%, while operating margin declined 40 basis points to 10.5% from the year-ago quarter due to higher operating expenses. Both selling, general and administrative expenses and depreciation expenses increased in the quarter.

Following the dismal results, Kohl’s cut the upper end of its earnings guidance from a range of $4.15 - $4.45 per share to $4.15 - $4.35 per share for fiscal 2013.

Overall, we are encouraged by the company’s strong brand portfolio. It has expanded in the apparels, fashion jewelry/beauty brand and cosmetic categories. Kohl’s has been working on improving its merchandising and execution strategies and aims to increase assortments and expand the number of private and exclusive brands.

Furthermore, through its global inventory visibility project, it aims to better manage in-store inventory, which will help improve in-store pickup for online orders. In addition, Kohl's is working toward price management strategies to increase savings. The company has also made aggressive investments to develop and upgrade its e-commerce business, which is quite encouraging.

However, the U.S and some international markets have been witnessing a challenging retail/sales environment as consumers are more conscious about their spending habits and avoid any unnecessary expenses. The restrained consumer spending environment in the U.S. emanated from the recent hike in payroll taxes and higher gas prices. Besides taxes, weak pay and a tepid rate of hiring also curbed consumer spending leading to lackluster sales. We believe the gloomy consumer spending environment will not improve much in the next few quarters and therefore prefer to be on the sidelines.

Kohl’s holds a Zacks Rank #4 (Sell). Other retail stocks, which have been performing well include Haverty Furniture Cos. Inc. (HVT - Snapshot Report), Kirkland’s Inc (KIRK - Analyst Report) and Fortune Brands Home & Security (FBHS - Snapshot Report), all of them with a Zacks Rank #1 (Strong Buy).

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