March 15, 2024

In today’s note, we discuss the recent earnings reports from Kohl’s (KSS), Kopin Corp (KOPN) and Volkswagen AG (VWAGY).

Comments on Earnings

Kohl’s Corporation (KSS) – Investors see Kohl’s as a broken company left behind by time, trends and technology, with unsettled leadership, further pressured by bloated inventory, a possible recession, and rising labor and goods costs. Major changes, however, are underway, led by a refreshed board and new CEO (Tom Kingsbury). Kingsbury is a proven operator whose mandate and expertise is to restore and upgrade rigor and discipline in the company’s operational performance. The company’s profits and free cash flow, while weakened, are resilient. The debt burden is reasonable but being trimmed further. While the turnaround carries risks, the deeply undervalued shares provide a margin for safety.

Kohl’s reported a strong enough quarter compared to year-ago results and consensus estimates. Compared to management’s guidance provided a year ago, full-year revenues were in line and the operating profit margin was a tick above the 4.0% target – both encouraging indicators of management’s ability to execute, understand its operations and economic environment, and benefit from perhaps a bit of luck. The full-year gross margin expanded by nearly 3.5 percentage points.

Guidance for fiscal 2024 calls for flat store sales but a 15% decline in high-margin credit card revenues which is an incremental disappointment compared to estimates. Guidance for a wide spread in operating margin (range is 3.6% to 4.1%), which would at best equal 2023 results, and flat per-share earnings, were disappointing to investors hoping for more.

We view this otherwise uninspiring guidance differently: turnarounds are messy and never happen exactly as planned. Stability and cash generation are key. Kohl’s guidance points to exactly this: stable revenues, stable profits and stronger free cash flow due to less need for capital spending. And, all of this could happen in a year with one fewer week due to the calendar timing. As guided, Kohl’s will generate about $550 million in free cash flow – equal to 20% of the company’s current market value. And, nearly 40% of this cash will be returned to shareholders in hard, directly pocketed cash, through dividends. Much of the remainder will help trim the company’s reasonable debt burden. The company remains on-track to reach its 7-8% margin target and 2.5x leverage target. Kohl’s shares trade at a grim 3.0x estimated 2024 EBITDA.

Kohl’s continues its operational turnaround that focuses on basic blocking and tackling on merchandising, providing incremental opportunities for gifts and impulse purchases, and controlling expenses and inventory. A new initiative will bring Babies “R” Us products and gift registries into Kohl’s stores – this should help boost traffic and likely bring some incremental profits. Another worthy initiative is to expand its credit cards into co-branding.

All in, we continue to like the Kohl’s turnaround.

In the quarter, revenues fell 1% and were 1% below estimates that called for flat sales. Same-store sales fell 4%. Adjusted earnings of $1.67/share compared to a $(2.49) loss a year ago and were 29% above estimates. EBITDA of $486 million compared to a $(102) million loss a year ago and was 5% above estimates.

Kopin Corporation (KOPN) – This small company is developing high-performance optical display technologies, including headsets and other applications, for military, enterprise, industrial and consumer products. Since its launch in 1992, the company had been run as a money-losing research hobby by its brilliant founder. However, seismic changes are underway at Kopin that look poised to radically change this company’s trajectory, most notably that the founder has stepped away. He has been replaced by a capable outsider who is focused on creating a sustainably profitable and growing business. Kopin is well-funded and has zero debt. While the risks are high, so is the potential reward.

The company reported a disappointing quarter, led by weaker revenues and a negative product gross margin (lost money before subtracting research and overhead costs).

Another disappointment is that Kopin missed its goal of generating positive free cash flow for the year. Weakness in Chinese orders (we see this source of revenues eventually going to zero given the emerging tech cold war) and some delays due to production changeovers hurt fourth-quarter revenues and profits. Also, Kopin issued another 3.1 million shares (cash proceeds of $7.5 million) in early 2024 despite assurances that it was done selling new shares. The company had $18 million in cash at year-end, so the equity offering adds to this balance.

The shares are getting hit today due to the disappointments. We suspect that KOPN shares have a meme flavor to them, given their thin trading volume and theoretically unlimited upside driven by the company’s whiz-bang new technologies. For patient turnaround investors, this hyper-volatility needs to be tolerated and if possible exploited. Key to success with this stock is the willingness to lose one’s entire investment if it all unravels, as this mindset will provide the fortitude necessary to endure near-term share price downdrafts like today’s.

One additional risk is that we have only limited understanding of the merits and markets for the company’s technology. We are not tech experts. So, if management is overstating the commercial value of Kopin’s opportunity, we will be unable to recognize this until it is too late. However, for now, we accept what management is saying, even if some grains of salt come with that acceptance.

Progress in this turnaround is slower than we and management anticipated. However, progress is being made. The company’s operations are much better aligned toward being a profit-making organization, it is receiving orders for real products and the backlog is now $55 million. Given the company’s tiny size, the increase in orders will require reconfiguring Kopin’s manufacturing space, an inventory build and other lumpy changes that make the near-term financials look awful. New technology advances offer promising new products in the reasonably foreseeable future, but these for now are seen only in higher expenses. Also, the company continues to spend heavily on litigation, an expense which we anticipate will roll off over the next several quarters.

The multi-year endgame is our focus, not the interim volatility surrounding the progress.

In the quarter, revenues fell 30% and were 6% below estimates. The net loss of $(0.06)/share compared to a loss of $(0.07) a year ago and was sharply below estimates for a $(0.02) loss.

Volkswagen AG (VWAGY) – Volkswagen is one of the world’s largest car makers, with a portfolio of brands including Volkswagen, Audi, Porsche and Lamborghini, as well as commercial trucks and a financial services unit. Our thesis on VW has yet to play out. Despite new leadership and the Porsche IPO, the shares remain depressed. Major issues include its China exposure (38% of unit volume), a large but unsettled bet on electric vehicles, complicated governance structure, in-car software problems, and the likely effects of a recession. VW has a sturdy balance sheet and sizeable profits and free cash flow.

VW reported a reasonably good quarter, but the Cariad car software unit continues to generate a loss and guidance was weak (perhaps a 5% increase in sales, minimal margin improvement and a sharp decline in net cash flow). The outlook for China was uninspiring, as competition is increasingly aggressive. These issues weigh on the share price. Investors holding the remarkably discounted shares will need similarly remarkable patience as VW is doing little to assuage concerns that it is making no strategic or financial progress during a period of economic growth.

While the 7.7% dividend yield is appealing (and is well-covered), it isn’t enough by itself to justify holding the shares if management doesn’t start moving with more alacrity to cut costs, slash capital spending and provide other shareholder value enhancements. We remain patient entirely due to the share value.

As a side note, we continue to be disappointed in VW’s disclosures. Like nearly all European companies, VW provides an overload of annual disclosures (a 468-page annual report) but minimum quarterly disclosures. If VW wishes to attract any of the vast capital hoard within the United States, it needs to do a much better job of providing the quarterly information that those investors require.

In the quarter, sales rose 14.5% and were 7% above estimates. The operating margin (reported as “Operating Result”) of €6.3 billion rose 25% from a year ago.

Friday, March 15, 2024, Subscribers-Only Podcast:

Covering recent news and analysis for our portfolio companies and other topics relevant to value/contrarian investors.

Today’s podcast is about 11½ minutes and covers:

• Comments on earnings
• Comments on recommended companies
  
  • Frontier Airlines (ULCC) – Possible benefits from its Airbus-only fleet
  • Advance Auto Parts (AAP) – Activist gets three board seats.
• Elsewhere in the markets
  
  • The only certainty in economic forecasting is that the crystal ball gazers get it wrong.

Please know that I personally own shares of all Cabot Turnaround Letter recommended stocks, including the stocks mentioned in this note.

Portfolio

Disclosure: The chief analyst of the Cabot Turnaround Letter personally holds shares of every Rated recommendation. The chief analyst may purchase securities discussed in the “Purchase Recommendation” section or sell securities discussed in the “Sell Recommendation” section but not before the fourth day after the recommendation has been emailed to subscribers. However, the chief analyst may purchase or sell securities mentioned in other parts of the Cabot Turnaround Letter at any time. Please feel free to share your ideas and suggestions for the podcast and the letter with an email to either me at bruce@cabotwealth.com or to our friendly customer support team at support@cabotwealth.com. Due to the time and space limits we may not be able to cover every topic, but we will work to cover as much as possible or respond by email.

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