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Trading the Revival of Retail

Trading the Revival of Retail

It was just a few months ago when we all heard that retail was dead. Analysts were explaining that consumers had permanently switched to online shopping which was more convenient and usually less expensive. In this environment, traditional department stores just couldn’t compete.

Well, that was several months ago, Now, traders seem to realize that the announcements of the death of retail was premature. The sector will undoubtedly face some significant struggles in its battle with online giants. But some retailers, including a department store, could well survive and even prosper.

Among the potential winners in the physical world is Kohl’s Corp. (NYSE: KSS). The stock sold off when the news was bad but has been a market leader in the rebound of the sector.

KSS

Strong Earnings and New Products

Kohl’s has been operating since 1962 and offers customers exclusive brand apparel, shoes, accessories, and home and beauty products. Brands include Simply Vera Vera Wang, Sonoma, APT 9, Croft & Barrow, Jennifer Lopez, Food Network, as well as national names like Levi’s, Dockers, and Columbia.

Recently, Kohl’s has begun working with other industry giants. Its partnership with Amazon, for example, where it started selling the company’s smart home products and accepting the online retailer’s returns, ramped up earlier this year.

Next, customers will soon be able to buy Aldi groceries at Kohl’s, as the retailer announced that it will be renting out some of its extra store space to a whole list of new partners.

Recently, the company reported better-than-expected results for its fourth quarter. Adjusted earnings of $1.87 were well above the Zacks Consensus Estimate of $1.77.

Among the most important metrics for retailers is comparable store sales. This figure tracks operations at stores open at least one year. For Kohls, sales rose 6.3% compared to a 2.2% decline reported in the same quarter a year ago.

After the strong year, Kohl’s management team told analysts to expect slow growth in the next year. They expect comparable store sales growth in the range of flat to a rise of 2%, while revenue growth is anticipated in a band of negative 1% to positive 1% for 2018.

But, cost controls should help the company improve its gross margin which is expected to increase by 0.10% from last year. Management expects earnings to fall within the range of $4.95 to $5.45 per share.

Analysts responded to the guidance by raising their estimates. The Zacks consensus estimate trend has moved higher, from $4.64 per share to $5.20 per share. Earnings estimates for 2019 are on the rise as well, increasing dramatically from $3.58 per share to $5.53 per share in the last 60 days.

Value, Even After Doubling

Based on expectations, even after the stock price has moved sharply higher in the past few weeks, KSS is priced at a discount to the stock market and could be attractive to value investors. The stock is priced at less than 13 times this years expected earnings.

The price to earnings (P/E) ratio is well below its historic highs.

P/E ratio

Source: Standard & Poor’s

The stock is also priced well below the S&P 500’s average P/E ratio and is inexpensive when compared to the Retail-Regional Department Stores industry P/E ratio of about 13.6.

Trading A Potential Uptrend

When a stock is expected to move higher, traders could consider obtaining long exposure to the stock to profit. A number of options strategies could be used to meet this objective.

Among those strategies is a bull put spread that could be used. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which is in an up trend.

bull put spread

Source: The Options Industry Council

This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.

Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.

Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.

A Specific Trade for KSS

For KSS, a bull put spread could be opened with the March 29 put options. This trade can be opened by selling the March 29 $61 put option for about $0.65 and buying the March 29 $60 put for about $0.40.

This trade would result in a credit of $0.25, or $25 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.

The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $1.00 ($61 – $60). This is multiplied by 100 since each contract covers 100 shares.

Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $75 ($100 – $25).

The potential gain is about 33% of the amount of capital risked. This trade will be for about two weeks and the annualized rate of return provides a significant gain.

The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy also has a high probability of success.

These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider

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